2010 - nbs.sk · ble development in 2010 was also seen in almost all other sectors of the...

FINANCIAL

STABILITY REPORT

2010

NÁ

ROD

NÁ B

AN

KA S

LOVE

NSK

A

FIN

AN

CIA

L STA

BILI

TY R

EPO

RT 2

010

FINANCIAL

STABILITY REPORT

2010

Published by:© Národná banka Slovenska

Address:Národná banka SlovenskaImricha Karvaša 1813 25 BratislavaSlovakia

Telephone:+421 2 5787 2141+421 2 5787 2146

Fax:+421 2 5787 1128

http://www.nbs.sk

All rights reserved.Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.

ISBN (online) 978-80-8043-172-3

http://www.nbs.sk

3NBS

FINANCIAL STABILITY REPORT2010

CONTENTS

EXECUTIVE SUMMARY 4

1 EXTERNAL CONDITIONS FOR FINANCIAL STABILITY 6

1.1 The global economy 71.2 The EU and euro area 81.3 The V4 countries 81.4 International financial markets 91.5 EU/euro area banking sector 111.6 Risks to domestic financial stability

from external conditions 13

2 SLOVAK ECONOMY DEVELOPMENTS AS THEY AFFECT FINANCIAL STABILITY 18

2.1 Overall development of the Slovak economy 19

2.2 Medium-term risks from the domestic macroeconomic environment 22

3 NON-FINANCIAL CORPORATE AND HOUSEHOLD SECTORS 24

3.1 Non-financial corporate sector 253.2 Household sector 273.3 Medium-term risk in the

non-financial corporate and household sectors 28

4 FINANCIAL SECTOR DEVELOPMENTS AND RISKS 29

4.1 The banking sector 304.2 The insurance sector 404.3 The collective investment sector 41

4.4 The pension saving sector 434.5 Macro stress testing 45

5 THE TARGET2-SK AND EURO SIPS PAYMENT SYSTEMS – SECURITY AND RELIABILITY IN 2010 49

ANNEXES1 Effective taxation of the financial sector 542 The effect of the financial crisis on

public finance positions 613 Interest rates on long-term housing

loans to households in the Slovak Republic 74

3.1 The key factors that may have affected the development of interest rates on long-term housing loans to households in Slovakia 75

3.2 Interest rates on housing loans to households with an initial rate fixationperiod of up to 1 year (in the euro area) 76

3.3 Analysis of interest rates in Slovakia with an initial rate fixation period of up to one year 78

3.4 Analysis of interest rates in Slovakia with an initial rate fixation period ofbetween 1 and 5 years 80

3.5 Effect of property prices on housing loan interest rates 81

ABBREVIATIONS 84

LIST OF CHARTS, TABLES AND BOXES 86

4NBS


EXECUTIVE SUMMARY

The conditions for financial stability in Slovakiaimproved during the course of 2010. This was mainly due to the recovery of the Slovak econo-my, as reflected in relatively strong GDP growth.The most significant driver of domestic econom-ic growth was the upturn in external demand. In the banking sector, credit risk was mitigated by growing sales in industry and the gradual stabili-sation of the labour market. The banking sector’s profitability in 2010 was substantially higher thanin the crisis year of 2009, boosted mainly by in-come from retail banking operations. Neverthe-less, the profitability of individual banks showedquite considerable divergence. The financing ofhouseholds picked up amid relatively low market rates and an intensification of competition in thebanking sector. This led to a moderate decline in the sector’s aggregate capital adequacy ratio in 2010. The banking sector’s strong resilience to adverse scenarios was confirmed in stress test-ing, which indicated that the most significant riskfacing the sector as a whole continued to be cor-porate credit risk. Some banks, however, showed a greater exposure to household credit risk. Sta-ble development in 2010 was also seen in almost all other sectors of the financial market. Only thenon-life insurance sector failed to rebound from the slump in 2009; the unfavourable situation in its main lines of business was caused by strong competition and weak sales. As for the payment system in 2010, it functioned smoothly and with-out any disruptions.

Turning to the external environment, the most probable scenario over the medium-term hori-zon is that global economic growth will continue to recover slowly and that the marked differenc-es between the pace of GDP growth in differentcountries and regions will persist. This expected development is, however, subject to several risks on the downside that may, directly or indirectly, affect conditions for domestic financial stabil-ity. In terms of size, the most significant of thesepotential risks appears to be an escalation of the sovereign credit risk of the euro area peripheral countries. This is because of the direct impact that the materialisation of these risks would have on the balance sheets of many banks in the euro area. Due to elevated tension in long-

term funding markets, several euro-area banks will also have difficulty in refinancing a largeamount of their debts. This, along with the need for banks to continuing increasing their capital for financial risk coverage, will push for furtherdeleveraging. The slow process of repairing bank balance sheets and the persisting uncertainty surrounding banking sector risks will continue to dampen the economic recovery in the euro area. The external environment could also be adversely affected by high prices of commodi-ties (especially oil) and the resulting inflationarypressures, by “hard landings” of emerging econ-omies (including China) and by the further de-ferral of fiscal consolidation plans in the UnitedStates and Japan.

As for the non-financial corporate and house-hold sectors in Slovakia, their situation improved somewhat during 2010, especially in the case of export-oriented industries. The financial situa-tion of households has yet to pick up to an ap-preciable extent, given the lack of a clear upturn in the labour market situation such that would stabilise the generation of household income. If household income growth fails to accelerate, low consumer demand may continue to limit profits in those industries that depend on do-mestic household consumption. In the outlook for 2011, consumer demand will also be adverse-ly affected by rising inflation, driven by factorsin the global environment. Such a development would escalate credit risk in the bank sector.

The Slovak economy in 2011 and 2012 is ex-pected to benefit from the continuing growthin external demand and fixed investments andfrom the gradual recovery of private consump-tion. It is therefore most probable that do-mestic financial stability will be supported bysound macroeconomic developments. The situ-ation in the near term will also be determined by public finance consolidation measures,which will, depending on their scope and tim-ing, represent a demand shock for household disposable income and possibly also for the unemployment rate and corporate expenses. Although the ongoing fiscal consolidation willin the short-term horizon (especially in 2011)

5NBS


E X E C U T I V E S U M M A R Y

have a dampening effect on economic growth,the success of its implementation is a sine qua non for the strengthening of long-term finan-cial stability. The potential medium-term risks from the implementation of insufficiently am-bitious fiscal adjustment are significant. Beinga small economy, Slovakia is exposed to the risk of asymmetric market reactions to fiscal devel-opments in smaller countries, even where the fundamentals are relatively sound.

Looking at the long-term financial stability inSlovakia in the light of recent negative experi-ences in certain euro area countries (and in other countries with fixed exchange rate regimes),closer attention will need to be paid not only to the soundness of public finances, but also tostructural features of the economy and to the prudential aspects of the banking sector, which would support sustainable pace of borrowing in the private sector.

1

EXTERNAL CONDITIONS

FOR FINANCIAL STABILITY

C H A P T E R 1

7NBS


C H A P T E R 1

Chart 1 GDP in Q4 2010 (index, Q2 2008 = 100)

Source: IMF – World Economic Outlook, April 2011.Note: CEE and CIS = central and eastern Europe and Common-wealth of Independent States.

130

120

110

100

90

United StatesEuro areaJapanCEE and CIS

Middle East and North AfricaEmerging AsiaLatin America

Table 1 World output and world trade volume (annual percentage changes)

2008 2009 2010 2011(p) 2012(p)

World output 3.0 -0.5 5.0 4.4 4.5

Advanced economies 0.2 -3.4 3.0 2.4 2.6

United States 0.0 -2.6 2.8 2.8 2.9

Euro area 0.4 -4.1 1.7 1.6 1.8

Japan -1.2 -6.3 3.9 1.4 2.1

Emerging and developing economies 6.1 2.7 7.3 6.5 6.5

Central and eastern Europe 3.2 -3.6 4.4 3.7 4.0

Asia 7.7 7.2 9.5 8.4 8.4

China 9.6 9.2 10.3 9.6 9.5

World trade volume 2.7 -10.9 12.4 7.4 6.9

Source: IMF – World Economic Outlook, April 2011.Note: Data for 2010 and 2011 are forecasts.

1 EXTERNAL CONDITIONS FOR FINANCIAL STABILITY

1.1 THE GLOBAL ECONOMY

The global recovery in 2010 proceeded very un-evenly across advanced and emerging econo-mies.

According to the International Monetary Fund (IMF), global economic output in 2010 increased by 5% year-on-year.1 In line with expectations, world economic growth slowed in the second half of the year, as inventory rebuilding and, as a consequence, industrial production and trade moved into lower gear. In advanced countries, economic growth was modest and unemploy-ment remained high. By contrast, many emerg-ing economies saw signs of overheating and rising inflation pressures, particularly due tolarge-scale inflows of foreign capital. Growthin emerging countries was also boosted by ro-bust private demand and accommodative poli-cies. Global economic activity thus appears to be “two-speed”, although even within the cat-egories of advanced and emerging countries there are substantial differences in the pace ofGDP growth (Table 1). The countries in which the recovery of activities is lagging are mainly those which were hardest hit by strong finan-cial shocks during the crisis, whether due to the bursting of real estate bubbles or excessive ex-ternal debt (Chart 1).

The pattern of weak activity in advanced econo-mies and strong growth in emerging economies will continue in the short-term horizon.

The IMF’s outlook for the period 2011–2012 assumes that economic activity in advanced countries will remain modest even if forecasta-

1 IMF – World Economic Outlook, April 2011.

8NBS


C H A P T E R 1

Table 2 Real GDP growth (%)

Quarter-on-quarter change Year-on-year change

2009 2010

2008 2009 2010 2011(p) 2012(p)Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Euro area -2.5 -0.1 -0.4 0.3 0.4 1.0 0.4 0.3 0.4 -4.1 1.8 1.5 1.8

EU -2.4 -0.3 0.3 0.5 0.4 1.0 0.5 0.2 0.5 -4.2 1.8 1.8 1.9

Source: Eurostat. Note: Based on seasonally adjusted data. The data for 2011 and 2012 are taken from the European Commission‘s European Economic Fore-cast – Spring 2011.

ble risks do not materialise (see Chapter 1.6 for more details) and a major dent in the relatively high unemployment rates is not to be expected. This subdued activity is caused mainly by the fact that necessary fiscal consolidation measureshave reached, and in some cases exceeded, the limits of sustainability; energy prices are rising, and repairs and reforms of financial systems inadvanced countries are proceeding at a slow pace. Emerging economies are expected to maintain a brisk pace of growth based on strong domestic demand and high commodity prices. These economies will continue to face inflationpressures, stemming mainly from climbing food prices and from overheating in the form of rapid growth in lending and asset prices.

1.2 THE EU AND EURO AREA

The European economy continued to recover in 2010 and is expected to maintain modest growth in the near term, too. The main risk is the situa-tion in financial markets and banking sector,which remains fragile owing to the still precari-ous sustainability of public finances in certainMember States.

In the EU/EA-17, GDP growth was relatively strong in the first half of 2010 and then, in line with ex-pectations, it slowed significantly in the secondhalf of the year. This was caused by a decline in global economic activity, brought on by the fad-ing-out of the impetus from restocking and from some of the temporary stimulus measures intro-duced by national governments. Economic activ-ity in some EU/EA-17 countries was adversely af-fected by very bad weather conditions in the last quarter of 2010. The main driver of the European economy in the near term (2011) will be export-oriented economies, given the relatively buoyant

outlooks for external demand. This demand will come not only from expanding emerging econo-mies, but also from the new government stimulus measures adopted in the United States in Decem-ber 2010, which are designed to boost investment and private consumption. The fruits of these de-velopments will be seen in capital formation as well as in stronger consumer demand. Economic development in the EU/EA-17 will, however, be ad-versely affected by the fragile situation in financialmarkets and in the EU banking sector, stemming from doubts about the sustainability of public fi-nances in certain countries. Household income, and consequently household consumption, may come under further downward pressure from ris-ing commodity prices. Domestic demand will also be dampened by the continuing fiscal consoli-dation in the EU periphery. The heavily indebted private and government sectors will face higher debt servicing costs, as the ECB “normalises” its interest rates, i.e. raises them to more standard levels.2 The increasing divergences in economic developments within the EU will continue.

1.3 THE V4 COUNTRIES

Economic recovery in the V4 region was uneven in 2010, owing to differences in the pre-crisis con-ditions in the individual countries. The short-term outlook is favourable due to improving external conditions, but it is accompanied by high uncer-tainty about the situation in the medium term.

The speed at which the constituent economies of the V4 region underwent recovery was to a large extent determined by factors such as their struc-ture, the size of their macroeconomic imbal-ances before the crisis, and the degree of their dependence on short-term external financing.In general, economic growth was slow owing to

2 Financial markets expect the ECB to raise its key rates by 0.25 percent-age points on three occasions dur-ing 2011. The ECB carried out the first such increase on 7 April 2011,effective from 13 April 2011, raisingthe key rates from their historically lowest levels.

9NBS


C H A P T E R 1

Chart 2 GDP on a quarterly basis (index: Q3 2008 = 100)

Source: Eurostat.

108

106

104

102

100

98

96

94

92

90

Czech RepublicPoland

HungarySlovakia

2008 2009 2010 Q3 Q4 Q1 Q2 Q1 Q2Q3 Q4 Q3 Q4

Chart 3 Advanced equity markets (monthly data; index: 2007=100)

Source: IMF – World Economic Outlook, April 2011.

120

110

100

90

80

70

60

50

40

30

20

10

0

DJ EURO STOXX PRC S&P 500

TOPIX INDEX (TOKYO)

200

0

200

1

200

2

200

3

2004

200

5

200

6

2007

200

8

2009

2010

weak domestic demand and to external factors – financial market turbulences in the euro areahad a negative effect on growth. The pick-up ofproduction in Germany in the second quarter of 2010 was the main driver of the region’s growth. The robust expansion of the German economy will continue to support this growth during 2011. Investor confidence in the V4 region is ex-pected to bolster ambitious fiscal consolidationin each of the V4 countries. The effect of this pol-icy in the short-term horizon will be to dampen private consumption. The main risks to the me-dium-term outlook are, first, uncertainty aboutthe sustainability of euro area economic growth amid high internal imbalances and, second, the vulnerability of the euro area’s banking sectors. The region may, on the other hand, capitalise pri-marily on its cost competitiveness, flexible mar-kets, and the various ongoing reforms to support the business environment.

1.4 INTERNATIONAL FINANCIAL MARKETS

In 2010, global financial markets were domi-nated by fears about the sustainability of fiscalpolicies in euro area peripheral countries and the slowdown of growth in the global economy. The extent to which world financial markets supporteconomic growth will not be significant in thenear-term horizon.

Mounting sovereign risks and fears of financialcontagion in the first half of 2010 brought theglobal financial system to the brink of anothercollapse at the beginning of May. In response, EU governments implemented several rescue measures and the ECB applied non-standard policies,3 which together managed to stabilise the situation within a short time. From mid-2010, the risk aversion trend abated and inves-tors restructured their portfolios by increasing the proportion of riskier assets. The US equity market in 2010 was boosted by strong corpo-rate profits and approached its pre-crisis peak.The performance of European and Japanese equity markets lagged far behind, owing to in-vestor fears about the soundness of the finan-cial sector and about the sufficiency of externaldemand for the export-dependent economies (Chart 3). The best-performing equity markets were those in emerging Latin America and emerging Asia (Chart 4), which were boosted by inflows of foreign capital. Their volatilityclimbed to high levels in May amid turbulences related to the Greek bailout (Chart 5).

Prices of all significant commodities rose sharp-ly (Chart 6). Base metal prices soared on the ba-sis of strong demand from emerging countries and a slow supply response. Food prices were affected by the flood-related disruption of foodsupplies. Oil prices were driven up by better

3 For further details, see the Financial Stability Report for the First Half of 2010, http://www.nbs.sk/_img/Documents/ZAKLNBS/PUBLIK/SFS/SFS2010A-1.pdf

http://www.nbs.sk/_img/Documents/ZAKLNBS/PUBLIK/SFS/SFS2010A-1.pdf



10NBS


C H A P T E R 1

Chart 4 Emerging equity markets (weekly data; index: 2007=100)


Chart 5 Implied volatility in equity markets measured by the VIX index (daily data; %)

Source: CBOENote: The VIX is an index of volatility that measures the implied volatility of equity markets from option prices on the S&P 500 in-dex. The VIX expresses the size of investors‘ risk aversion – a value of more than 20 indicates a high aversion to risk and a value of more than 50 indicates that investors have very serious concerns.

Chart 6 Commodity price indices (USD; monthly data; 2005=100)

Source: International Financial Statistics.

250

200

150

100

50

0

Agricultural commoditiesBrent oil

FoodMetals

2005 2007 2008 2009 2010 2006

than expected macroeconomic conditions in the second half of 2010, by supply-side factors (OPEC responding with lower than expected extraction), and by quantitative monetary eas-ing in the United States.4 The weakening of the US dollar against almost all currencies in the second half of 2010 helped to some extent to dampen the full economic impact of high com-modity prices.

As risk aversion fell in the second half of the year, interest rate spreads returned to low levels and government bond yields rebounded (Charts 7 and 8). From November 2010, when the Federal Reserve System announced the continuation of its quantitative easing programme,5 interest on US government bonds with a maturity of 5 to 10 years increased by more than 100 basis points. Rates were also driven up by the fact that fiscalpackages agreed to on 6 December 2010 were far more substantial then the markets had ex-pected (worth USD 800–900 billion over a two-year horizon). Although this is contributing an estimated 0.3% to 1% to US GDP growth in 2011, it is also significantly increasing the risk that gov-ernment bonds will sell off if measures to repairpublic finances are not taken in the medium-term horizon.

Unlike the Greek crisis in May 2010, the Irish cri-sis in the subsequent November did not spread

to financial markets; nevertheless, interest ratespreads on government bonds and corporate CDS spreads in euro area peripheral countries remain at elevated levels (Charts 9 and 10).6,7 This indicates that the vulnerability of euro area

4 From January 2011, oil prices rose also as a consequence of the civil unrest in North Africa and the Middle East. These developments also had a negative effect on inves-tor sentiment in global financialmarkets during the course of March 2011.

5 QE2 – the Federal Reserve System is to purchase USD 600 billion of longer-term US Treasury securities by the end of June 2011.

6 Yields on Greek, Irish and Portuguese government bonds jumped up in March 2011 after the EU agreed on a new European Stabilisation Mechanism (ESM) – a permanent mechanism that is due to commence operation in mid-2013. Under the ESM, a euro area country might default and private investors will bear the related losses. The ESM will have a total subscribed capital of €700 billion (comprising paid-in/callable capital and govern-ment guarantees), which will allow it to borrow up to €500 million by issuing AAA-rated debt. Not only will the ESM be able to lend to the respective country, it may also, in exceptional cases, purchase bonds of this country in the primary market, subject to the consent of the country and to strict measures for supporting economic growth and budget deficit reduction.

7 On 7 April 2011, Portugal officiallyrequested the EU and IMF for finan-cial assistance. At the beginning of May 2011, it was agreed to provide Portugal with €78 billion over three years for financing the publicdebt and supporting the banking sector. As in the case of Ireland, the markets reacted relatively calmly to Portugal being bailed out with funds from the European Financial Stabilisation Mechanism (EFSM) – a temporary stabilisation mechanism initially established for the bailout of Greece.

140

130

120

110

100

90

80

70

60

50

40

30

20

10

0

Asia Latin America

2005 2007

East Europe

2008 2006 2002 2004 2003 2009 2010

90

80

70

60

50

40

30

20

10

0 2009 2010 2007 2008 2005 2006

11NBS


C H A P T E R 1

Chart 7 Interest rate spreads on corporate bond yields (daily data; average in United States and Europe for specific rating grades;basis points)


Chart 8 Yields on 10-year government bonds (daily data; %)


Chart 9 Bank CDS spreads (10-year; median; basis points)


1,600

1,400

1,200

1,000

800

600

400

200

0

BB AAA

2005 2006 2007 2008 2009 2010

6

5

4

3

2

1

0

United States Germany

2005 2007

Japan

2008 2006 2009 2010

Chart 10 Spreads between yields on government bonds issued by selected countries and German government bonds (basis points)

Source: Eurostat, NBS calculations.

400

300

200

100

0

United States Europe

2005 2007 2008 2006 2009 2010

1,000

900

800

700

600

500

400

300

200

100

0

-100

Greece Spain Italy

Portugal Ireland Belgium

2008 2009 2010

periphery will remain elevated, as will the uncer-tainty surrounding the outcome of efforts to ad-dress the debt crisis in the euro area. Given that bank lending conditions in advanced economies are expected to improve only slowly, the chang-es in financial conditions will not be overly sup-portive to economic growth.

1.5 EU/EURO AREA BANKING SECTOR

The euro area banking system continues to face el-evated risks and pressure to trim balance sheets.

The EU banking sector faces significant risks. Atthe national level, the banking sectors exposed

12NBS


C H A P T E R 1

Chart 11 Real estate prices (quarterly data; index: 2005 = 100)

Source: OECD.

Chart 12 Bank deposit rates (changes in basis points)

Source: IMF – Global Financial Stability Report, April 2011.Note: The Chart shows deposit rates on new business up to one year.

140

120

100

80

60

40

20

0

Germany Netherlands Sweden

Ireland Spain United Kingdom

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

200

150

100

50

0

-50

Germany Greece Italy

Portugal Spain

2009 2010

to the greatest risk are those in countries whose governments have severe financial difficul-ties. Rising sovereign risk premia and declining sovereign credit ratings are raising the cost of borrowing for these banks. At the same time, the banks hold a substantial amount of their domestic countries’ debt, which is subject to high market risks in regard to the revaluation of these assets to fair value. Banks are facing el-evated credit risks due to governments’ auster-ity measures in order to repair public finances,which at the same time have a negative impact on the real economy and asset prices (especially real estate prices).

Banks from other EU countries also have a rel-atively high exposure to the EU periphery. The marking to market of these exposures does not give rise to large losses since the banks have, on average, up to 80% of the bonds in ques-tion in their held-to-maturity portfolios. These investments are, however, exposed to an el-evated credit risk associated with the poten-tial restructuring of the debts of the countries concerned. This risk is relatively high in certain countries – despite the existence of the Eu-ropean Financial Stability Facility (temporary or permanent) – due to negative outlooks for their potential GDP growth. This makes reduc-ing the debt burden to a sustainable level far more difficult. For banks in other EU countries,

the risk may be that investor fears spread to other assets of the periphery countries, for ex-ample covered bonds.

Among the other significant risks in the EU bank-ing sector were credit risk exposures to the com-mercial real estate sector. Property prices in sev-eral EU countries have undergone a correction since 2008 (Chart 11), but uncertainty about their further movement persists, given the out-look for future economic developments. Banks also now face a strong risk of asset impairment in respect of consumer loans and loans to small and medium-sized enterprises.

The banking sector also faces a high liquidity risk. The conditions under which banks may ob-tain long-term funding are particularly difficult,especially for banks based in countries that are perceived to represent a high default risk. There is little demand for bonds issued by the private sector in these countries; on the contrary, such assets are, in the circumstances, under pressure of being sold off by investors. The cost of refi-nancing is therefore rising sharply. In the period 2011–2012, European banks need to refinancelong-term funds in the amount of around €1.35 billion, at the same that sovereign funding needs are rising. This increases the risk that bank bond issues will be crowded out, in which event yields would rise and weak banks would be shut out

13NBS


C H A P T E R 1

of the market.8 Even for sound banks, tensions in long-term funding markets are now being exacerbated by regulatory changes that require assets to be backed with longer-term funding. The supply of long-term funding to European banks may be further limited by new regula-tory measures in the United States under which money market funds will only be permitted to invest in short-term securities. The European covered bond markets that banks customarily tap for long-term funding have a restricted ab-sorptive potential owing to the limited supply of high-quality collateral for these type of bond is-sues. With banks stepping up their efforts to ob-tain more secure primary deposits, the prices of these funds are also rising (Chart 12).

Although the capital position of euro area banks continued to improve in 2010, banks in those countries that have financial difficultieswill have to carry on increasing the amount and quality of their own funds in order to build up credibility.

The median value of the Tier 1 capital ratio for listed euro-area banks as at the end of 2010 was 10.6%. That represents a substantial improve-ment compared with the end of 2008, when the median value was below 8%. Nevertheless, the capitalisation of euro-area banks is weaker, and its improvement more modest, than that of banks in, for example, the United States or the United Kingdom. The improvement in the Tier 1 capital ratio was driven by increases in own capital from profits, the issuance of shares, andthe slower rise in risk-weighted assets. Some banks, seeking to conform with the stricter regulatory capital framework that is due to be introduced under the Basel III accord, also un-dertook deleveraging, mainly by selling corpo-rate securities and by reducing exposures to other financial institutions in the form of loansand securities. Those euro-area banks that face difficult conditions, particularly in relation to el-evated sovereign credit risks, will have to press on in the deleveraging process and bolster the quality and levels of their own capital, so as to cushion themselves against potential losses. Certain euro-area banks are obliged to return in the near term the state assistance that they re-ceived through capital injections and questions are being raised about the sufficiency of theircapitalisation.

1.6 RISKS TO DOMESTIC FINANCIAL STABILITY FROM EXTERNAL CONDITIONS9

The most significant negative risks in the short-term and medium-term horizons are:• that sovereign risks in the EU periphery esca-

late and possibly spread to other segments of the financial market, including the bankingsectors of advanced EU countries;

• that the banking sectors of advanced coun-tries are slow in recovering;

• that emerging economies, including China, have a hard landing and experience sudden capital flight as a result;

• that further rises in prices of oil and other commodities have a substantial impact on real incomes and that, especially in emerging and developing economies, food and energy price increases start an inflationary spiral;

• that the implementation of fiscal adjustmentplans in large advanced countries (the United States and Japan) is delayed.

The EU economy remains vulnerable due to substantial internal imbalances and structural problems for which an early solution cannot be expected.

Although the EU economy has a relatively fa-vourable short-term outlook – largely due to the effect of positive external factors – its de-velopment cannot be described as sound. The financial stability of the euro area is underthreat from excessive internal macroeconomic imbalances and from increasing divergence in economic growth. Solving these problems re-quires that Member States improve their fiscaldiscipline, that economies with current account deficits become more competitive, that condi-tions are created to increase the share of private consumption in countries with current account surpluses (particularly Germany), and that ef-fective mechanisms are established to address sovereign defaults and cross-border financialcrises in the EU and elsewhere. These questions are now occupying politicians, and progress was made last year in some areas concerning euro area governance. But some matters are politically demanding and time consuming, such as structural reforms in individual Member States aimed at strengthening the resilience of the euro area.

8 A large number of European banks are dependent on short-term central bank funding. In 2010, Eurosystem national central banks lent euro area banks €550 billion through refinancing operations,with €340 billion of that amount received by banks in Portugal, Ireland, Greece and Spain. The refinancing of banks through theEurosystem may be complicated by the deteriorating credit ratings of the countries and banks concerned, i.e. certain assets may become inel-ligible for central banks to accept as collateral in Eurosystem credit operations.

9 The risks identified are marked bystrong interconnection and a mu-tual feedback loop. This stems from the complex links between the real economy and the balance sheets of financial institutions, government,firms, and households. Instead ofidentifying potential scenarios and quantifying their impact, which would be extremely difficult, wetherefore, in this section, prefer to assess risks on a qualitative basis. A quantitative analysis of the impact of different scenarios onthe Slovak financial sector (basedon macro stress testing) is given in Section 4.7.

14NBS


C H A P T E R 1

Chart 13 Bank rollover requirement, 2011–2012 (In percent of total debt)

Source: IMF: Global Financial Stability Report, April 2011.

50

45

40

35

30

25

20

15

10

5

0

Debt maturing in 2011Debt maturing in 2012

Irela

nd

Germ

any

Portu

gal

Spai

n

Neth

erla

nds

Italy

Fran

ce

Belg

ium

Aust

ria

Gree

ce

Refinancing of the EU banking sector is currentlysubject to extensive complications, notably the strong financial links between countries and thebanking sector. The rise in tensions in the long-term funding market is caused by other factors, too (strong sovereign demand, Basel III).

At a time when financial markets have an el-evated sensitivity to risks concerning the sus-tainability of the public finances of certainMember States, it is becoming evident that the soundness of public finances is an importantfactor in banking sector stability. Financial mar-ket tensions arising from heightened sovereign risks are pushing up interest rates on govern-ment bonds. As a consequence, financing costsare rising for banks (some banks have been completely shut out of interbank markets) and for the entire private sector in the countries concerned. Bonds issued by residents of these countries are being sold off in financial mar-kets owing to the excessive volatility of their yields, high credit risks, and financial contagionrisks. This is a critical situation given the large amount of long-term funding that banks will need to refinance in 2011 and 2012 (Chart 13).The substantial mismatch between supply and demand in the long-term funding market is also being exacerbated by the strong sovereign de-mand for such funding and the pressure from new banking regulatory regimes that require

assets to be backed by longer-term funding. This situation is putting upward pressure on lending for households and enterprises. In the event of a more pronounced rise in aversion to sovereign risk, these mechanisms will continue to impair conditions for economic growth and financial stability in Europe.

A combination of the still-high banking sector credit risks in advanced countries and the refi-nancing difficulties outlined above means thatthe conditions for financial stability are veryfragile.

Analyses by the IMF show that the deleveraging process in advanced economies is progressing very slowly. The credit-to-GDP ratio is falling only gradually amid the slow increase in economic activity. However, the still-high amount of debt accumulated by households and enterprises in advanced countries is creating significant creditrisks for banks and it makes them vulnerable to changing sentiment in financial markets. Themost high risk credit assets include loans for real estate, loans to small and medium-sized enter-prises and consumer loans. Banks are seeking to mitigate these risks by increasing their own capital. This process, however, is complicated by financial market tension brought on by highersovereign risks. Persisting investor fears are pushing up equity and bond issuance costs. In such circumstances, banks may seek to delever-age more by adjusting the size of their balance sheets than by increasing capital. They will re-strict the supply of new loans, which – at a time when borrowing demand remains weak due to persistently high private sector debt – will act as a further drag on the economic recovery in ad-vanced countries. The reduction in bank balance sheets will accentuate the problems of excessive capacity in the banking sector, and competition for secure funding will put banks with weak busi-ness models under strong pressure. A key part of the solution to these problems is the consistent and credible implementation of fiscal consolida-tion plans, which must be supported with struc-tural policies aimed at raising the potential out-put of the countries affected. It is also necessaryto shed light on the situation in the euro area banking sector (for example, through credible stress tests)10 and to restructure banking systems so that they are more secure, efficient and com-petitive.

10 The results of the latest stress tests of key European banks will be published in June 2011. They are expected to confirm the strongneed for European banks to increase their own funds.

15NBS


C H A P T E R 1

Chart 14 Net capital flows (percent of GDP)

Source: IMF – World Economic Outlook, April 2011.Note: The data go up to the third quarter of 2010.

8

6

4

2

0

-2

-4

-6

-8

Emerging economiesAdvanced economies

2007 2008 2005 2006 2009 2010 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

If emerging economies have a hard landing, the repercussions for the global economy and finan-cial stability could be serious.

A further risk to the recovery of the global economy is that certain emerging economies of Latin America and South-East Asia, including China, could experience a hard landing. This risk is mounting due to the substantial foreign capi-tal inflows that began in the second quarter of2009 and the falling capacity of local economies to absorb them (Chart 14). The capital flows toemerging countries stem from the revival of in-vestor confidence in this type of investment andfrom carry trades, i.e. the efforts of investors toachieve better returns on their capital rather than tolerate the extremely low interest rates in advanced countries. Rapid economic growth is also being driven by the advantageous terms of trade in commodity-exporting countries and accommodative monetary policies. The reaction of politicians in the countries concerned indi-cates that they are seeking to mitigate the risks of overheating economies, rising private sector debt, and increasing asset price bubbles. Inves-tors, however, may have a different opinion onthe adequacy of the various measures (in their view, for example, it may be better for certain countries to let their currency appreciate than to raise interest rates, which only attracts further

capital inflows); this could give rise to suddencapital outflows and the bursting of bubblesin the property markets and credit markets of these countries. Since emerging countries have (according to the IMF) a 40% share in global consumption and a two-third share in global growth, such a turn of events would have seri-ous consequences for the global economy and financial stability.

Another risk to the further recovery of the global economy is the continuing trend rise in prices of oil and other commodities.

A further rise in oil prices (WTI and Brent) to above the level of USD 100 per barrel will have a strong deflationary effect on global economicgrowth. The strongest upward pressure on oil prices is coming from a combination of factors: the relatively benign short-term outlook for the world economy; the liquidity surplus in risky as-set markets driven up by (twofold) quantitative monetary easing in the United States; and geo-political tension in North Africa and the Middle East. Rising input prices are squeezing producer margins, with the result that consumer prices and inflation are going up. As real incomes even-tually decline and monetary policies are tight-ened more sharply in response (in both emerg-ing and advanced countries), the effect may beto weaken demand and, in time, to undermine the recovery of the world economy. These fac-tors will probably continue affecting oil prices in2011, but they are expected to become less sig-nificant thereafter. The situation may, however,be seriously complicated by any spreading of unrest to Middle East countries that are signifi-cant producers of oil.

Fiscal sustainability risks may easily spill over to other large advanced countries. The effective-ness of monetary stimulation through quanti-tative easing is also waning, but there is the risk that its cessation will, given the bad condition of public finances, result in a sharp rise in long-terminterest rates.

In the medium-term horizon the issue of fiscalsustainability and associated risks to financialstability concern also non-EU advanced coun-tries. The additional fiscal stimulus package ap-proved in the United States in December 2010 and the extensive injection of public funds into

16NBS


C H A P T E R 1

Chart 15 Foreign currency housing loans as a share of total housing loans (%)

Source: MNB, PBN, ČNB.Note: The data for Hungary are quarterly. In Poland, almost 90% of the foreign currency housing loans are denominated in Swiss francs.

Chart 16 Nominal exchange rate of V4 countries‘ currencies vis-à-vis the euro (daily data; index: 30.12.2005 = 100)

Source: Eurostat.Note: A rise/fall in the index represents depreciation/appreciation of the currency against the euro. As from 1 January 2009, the Slovak koruna was replaced by the euro at an irrevocable conversion rate of 30.160 SKK/EUR.

80

70

60

50

40

30

20

10

0 2009 2010

Hungary Czech Republic

Poland

130

120

110

100

90

80

70

SKK CZK

HUF PLN

2006 2007 2008 2009 2010

the Japanese economy11 is further complicat-ing the process of securing fiscal sustainabil-ity in these countries. In the United States, the longer it takes to produce a credible strategy for medium-term fiscal consolidation in the UnitedStates, the greater the risk of a sudden and sharp hike in US interest rates.12 The ultimate impact of such a development on global financial marketsand the world economy would be very unfavour-able. As inflation pressures mount, the scope formonetary stimulation through quantitative eas-ing is also diminishing. Furthermore, this policy has undesirable spillover effects on financial sta-bility by supporting riskier investments, strong capital inflows to emerging economies and ris-ing commodity prices. While such policies may bring short-term benefits, the structural prob-lems of economies and banking sectors cannot be addressed without the adoption of appro-priate reforms. The fact, however, that the Fed-eral Reserve System has stopped purchasing US government bonds, given the currently difficultfiscal situation in the United States, will mostprobably cause interest rates on these bonds to rise sharply. According to the IMF, the sensitivity of the United States and especially Japan to in-terest rate rises is considerable (greater than in most euro area countries), due to a combination

of factors: high and rising public debt and low public revenues.13

The economic and financial stability of the V4 re-gion is determined by sovereign risks in the euro area periphery.

The greatest risk to financial stability and eco-nomic recovery in the V4 region in 2010 was euro area sovereign risk, and it will remain so in the near term. This is because the V4 countries have a strong economic dependence on the euro area economy (especially Germany) and there are close cross-border financial links between thebanking sectors of the euro and the V4 countries. It is highly likely that financial market turbulencesin the countries of the region will make a return if there is again a widespread lack of confidence infinancial markets in the euro area and elsewherein the world.

The elevated vulnerability of the Polish and Hun-garian banking sectors persists due to their still-high share of foreign currency loans.

Despite measures taken by the competent au-thorities, a high share of the loans extended in Poland and Hungary are denominated in foreign

11 The Japanese public finances havein addition been heavily burdened by response measures to the earthquake and tsunami that hit the country in March 2011. The negative macroeconomic effectsof this event will most probably be confined to the short-term horizon,while the process of rebuilding the shattered infrastructure is expected to have positive effectsin the longer term. The intensity of the adverse effects will depend onthe length of drop-offs in industrialproduction and exports resulting from the extensive damage to nuclear power plants.

12 The IMF estimates that the US fiscaldeficit for 2011 will be at 10.8%(more than twice as high as the euro area fiscal deficit) and thatthe gross government debt to GDP ratio will be 110% in 2016.

13 IMF – Global Financial Stability Report, April 2011, page 21 (Chart 1.21).

17NBS


C H A P T E R 1

currency (Chart 15).14 The main reason for the rising share of foreign-currency financing in thepre-crisis period was the favourable interest rate differential. The high volatility of these countries’currencies (Chart 16) is contributing to the fact the large stock of unsecured foreign exchange loans is a source of the banking systems’ elevat-ed pro-cyclicality and of systemic risk. Deprecia-tion of the domestic currencies is increasing the debt servicing costs of borrowers (during the cri-sis, these costs were to a certain extent offset bythe decline in interest rates on the relevant for-eign currencies), and this is reflected in the risingcredit risk of local banks as well as of their non-resident parent undertakings. In addition to this risk there may be added liquidity risk (as was the case during the peak of the financial crisis). Sincedomestic banks do not have sufficient foreigncurrency funding, they rely on market financ-ing, mainly from their parent undertakings. The

funds in question are mostly short-term, which increases the maturity mismatch between assets and liabilities of domestic banks and contributes to systemic risk. In addition, any devaluation in the local currencies will lead to a rise in risk-weighted assets and hence an increase in capital requirements. In certain circumstances, a rela-tively substantial depreciation of local currencies may, through wealth effects, have an adverse im-pact on other markets (e.g., the real estate mar-ket or equity market) and on macroeconomic performance. Although the financial markets inthe relevant countries of central and eastern Eu-ropean are currently calm (investors are paying more attention to euro area sovereign risks), the recent cases of financial market instability spill-ing over from one EU country to another should increase the urgency for finding a solution to theforeign currency lending issue, which would be best tackled at the EU level.

14 In the Czech Republic, foreign currency housing loans as a share of the outstanding amount of housing loans represented only 1.06% as at the end of 2010.

2

SLOVAK ECONOMY

DEVELOPMENTS AS THEY AFFECT

FINANCIAL STABILITY

C H A P T E R 2

19NBS

FINANCIAL STABILITY REPORT 2010

C H A P T E R 2

Chart 17 GDP (annual percentage change)

Source: SO SR; EC–Economic Forecast, Spring 2011.1) EC forecast.

12

10

8

6

4

2

0

-2

-4

-6

Slovakia Euro area

2005 2006 2007 2008 2009 2010 20111)

2 SLOVAK ECONOMY DEVELOPMENTS AS THEY AFFECT FINANCIAL STABILITY

2.1 OVERALL DEVELOPMENT OF THE SLOVAK ECONOMY

Domestic macroeconomic conditions improved in 2010 and the Slovak economy returned to a growth trajectory. The structure of domestic economic growth in 2010 was dominated by an increase in net exports, thus confirming theeconomy’s dependence on external demand for Slovak exports and on economic conditions in trading partners. The determining factor of fu-ture development will be demand and its qual-ity. Depending on this, the growth potential of the Slovak economy may accelerate in the me-dium-term horizon. NBS expects that economic activity will continue growing in 2011, but more slowly than in 2010 owing to fiscal consolidationmeasures.

The rebound of business confidence and rise incorporate profitability in 2010 resulted in grow-ing investment demand. Lending to non-finan-cial corporations also picked up.

A positive aspect is that a trade balance surplus was maintained amid the recovery and that the current account deficit increased only slightly.The external debt of the private sector declined, while the increase in the national economy’s indebtedness was due to developments in the general government sector. Public finances wereproblematical in 2010 since the expected com-mencement of fiscal consolidation measures didnot materialise, the general government deficitremained very high, and public sector debt con-tinued to rise.

Because Slovakia retained the confidence of themarkets during the crisis of confidence in othersovereign states, it was able to borrow funds under relatively favourable conditions and the spreads on Slovak government bonds were not signifi-cantly affected. The major credit rating agenciesrate Slovakia at A+15 with a stable outlook.

The Slovak economy returned to a growth trajec-tory in 2010.

Real GDP for 2010 increased by 4% year-on-year, driven up mainly by external demand. Domestic demand grew largely as a result of the inventory cycle and investment demand, amid stagnating domestic consumption and general government final consumption. Since the economic recov-ery did not begin to pass through to the labour market until the end of the year, the labour pro-ductivity growth recorded in 2010 was based on a combination of GDP growth and falling em-ployment. Unit labour costs fell, since the rise in real labour productivity exceed the increase in real wages. The Slovak economy was operating below its potential in 2010, and NBS expects it to return to its potential in 201316.

Historically low inflation gradually increased.

The low annual inflation rate – it was in nega-tive territory in the first months of the year – in-creased during the course of 2010. It is assumed that inflation will rise quite markedly in 2011,given the recovery in economic activity in the domestic environment as well as the effect of taxchanges and sharper rises in prices of food, com-

15 Rated A+ by S&P, A1 by Moody’s, and A+ by Fitch.

16 NBS Medium-Term Forecast (MTF-2011Q1).

20NBS


C H A P T E R 2

Chart 18 Labour productivity and wages (annual percentage changes)

Source: SO SR.

10

8

6

4

2

0

-2

-4

Average real wageLabour productivity (at constant prices)

2005 2006 2007 2008 2009 2010

HICP inflation

Chart 19 Current account deficit coverage (EUR billions)

Source: NBS.

Chart 20 External indebtedness (% of GDP)

Source: NBS.

7

6

5

4

3

2

1

0

-1

-2

-3

-4

-5

FDI Short-term capitalPortfolio investmentLong-term capital Current account

2007 2008 2009 2010

50

40

30

20

10

0

Short-term external debtLong-term external debtNet external debt

2007 2006 2008 2009 2010

modities and energy-producing raw materials in global markets.

Weakening of the euro and low inflation helpedto maintain favourable price competitiveness.

The price competitiveness of Slovak exports, as measured by the index of the nominal effectiveexchange rate (NEER), improved in 2010. The de-

preciation of the NEER, combined with the effectof a negative inflation differential compared witha majority of relevant trading partner countries, led to a weakening of the real effective exchangerate. Another positive aspect is that the market share of Slovak exports in EU imports was not adversely affected by the crisis.

Current account balance remained largely un-changed.

The current account deficit for 2010 fell slightlyyear-on-year, to 3.5% of GDP. The trade balance surplus was preserved, albeit at a lower level (0.2% of GDP) than in 2009, with the amount of imported and exported goods both recording growth. Deficits in the services balance and cur-rent transfers balance were reduced, while the income balance recorded a marginal deteriora-tion (the rise in dividend payments to foreign in-vestors was offset by interest income in the NBSsector).

The inflow of funds to the capital and financialaccount continued to decline.

The surplus in the capital and financial accountfell to €538.4 million. FDI inflows picked up largelythrough increased liabilities to parent undertak-ings, while non-resident investments in the form of equity capital declined. The net outflow of funds

21NBS


C H A P T E R 2

Chart 21 General government deficit anddebt (% of GDP)

Source: SO SR, EC. 1) EC forecast.

Chart 22 Liabilities of general government (EUR billions)

Source: NBS, quarterly financial accounts.Note: Cumulative transactions over four quarters.

10

8

6

4

2

0

-2

-4

-6

-8

-10

Debt (rhs)

2006

50

45

40

35

30

25

20

15

10

5

02010 20111)20082007 2009

Deficit

10

8

6

4

2

0

-2

-4

-6 Q4 2008 Q1 2009

Debt securitiesEquitiesOthers Net financial assets

Deposits LoansCommercial loans Financial liabilities

Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010

in the portfolio investment category was caused mainly by rising demand among residents for for-eign securities and by lower non-resident demand for government securities. The inflows recordedunder the category of other short-term invest-ment stemmed from the repayment of loans that NBS had received from the Eurosystem through TARGET2. The introduction of the euro triggered an outflow of non-residents’ short-term depositsfrom accounts held with banks in Slovakia.

Trend rise in external indebtedness continues.

Gross external debt increased in 2010 and by the year-end stood at 74.8% of GDP. Short-term debt as a share of total gross external debt declined to 55.1%. The debtor position of Slovakia vis-à-vis the rest of the world declined marginally in net terms.

The plan to commence fiscal consolidation in2010 was not realised.

The general government budget deficit for 2010stood at 7.9% of GDP, again exceeding the budg-

et target (of 5%). The government has set itself the challenging goal of bringing the public defi-cit to below 3% of GDP in 2013.

Government borrowed without difficulty

The government’s annual borrowing in 2010 was its highest ever, at €9.5 billion. Of that amount, the government obtained €7.044 billion from the sale of bonds and the rest from the sale of Treasury bills and loan with a maturity of up to one year. The Debt and Liquidity Management Agency (ARDAL) made two benchmark bond is-sues (10-year and 15-year). Despite turbulences in European markets Slovakia obtained funds under very favourable conditions: the average in-terest rate on bonds issued in 2010 was 3.5% p.a. The risk premium on Slovak bonds had a slightly rising trend.

As regards the structure of general government borrowing in 2010, most of the funding was ob-tained through long-term debt securities; the proportion obtained through short-term fund-ing markets increased modestly.

22NBS


C H A P T E R 2

Box 1

Chart A Stocks of financial assets andliabilities (EUR millions)

Source: NBS. 1) Households and non-profit institutions serving households.

Chart B Net lending/borrowing (% of GDP)

Source: NBS. 1) Households and non-profit institutions serving households.

120

100

80

60

40

20

0

-20

-40

-60

Liabilities Net financial assets

Slovakia Non-financial corporations

General government

Households1)

Assets

40

20

0

-20

-40

-60

-80

2009 2010

Slovakia Non-financial corporations

General government

Households1)

2008

THE DEBTOR POSITION OF THE SLOVAK ECONOMY‘S SECTORS IN 2010

The overall indebtedness of the Slovak econo-my at the end of 2010 represented 57% of GDP (€37.6 billion). The net debt of the non-finan-cial corporate sector declined, and the debt of the general government sector increased (the

financial institutions sector had an almost bal-anced position). The net credit position of the sector of households and non-profit institu-tions serving households (NISH) fell slightly in relatively terms.

2.2 MEDIUM-TERM RISKS FROM THE DOMESTIC MACROECONOMIC ENVIRONMENT

The potential risks to financial stability in thedomestic environment are related mainly to:• developments in public finances,• the economy's growth potential being

lower than expected.

Risks from the domestic macroeconomic envi-ronment are persisting

The national economy returned to growth in 2010, which helped stabilise the financial posi-tion of (some) non-financial corporations. Therehas not yet been substantial pass-through of the recovery to household incomes. A positive aspect

is that Slovakia had a relatively short-lived reces-sion compared with other euro area economies. Despite operating in demanding conditions, the financial system in Slovakia remained stable.

The risks arising from the deteriorating position of public finances in Slovakia are persisting. Thesituation in the near-term will be determined by the consolidation of public finances, which,depending on its scope and timing, will cause a negative demand shock with repercussions for household disposable incomes (and possibly also unemployment) and for corporate costs.

It is important for the consolidation of public fi-nances that the economy potential picks up to a certain extent. If the growth in potential slows, it will become more difficult for the country tokeep debt ratios stabilised. Debt reduction must

23NBS


C H A P T E R 2

to a greater extent be achieved with primary balance contributions and interest payments.17 Revisions to the potential reveal that the assess-ment of the pre-crisis structural position was overly optimistic and that the general govern-ment deficit is largely a structural problem. Thismeans that a further recovery may help reduce the deficit to a limited extent only. Tax revenuelosses may be permanent or long-term, since, during the boom, several streams of tax revenue

(from financial assets, property) temporarily in-creased the revenue side of the budget.

It is, however, essential that the sector’s balance sheets are repaired. Slovakia, as a small economy, is also exposed to the risk of asymmetric market responses to developments in smaller economies, since markets have a tendency to react more sen-sitively to deficits in small countries, even wherethe fundamentals are relatively sound.

17 The debt position of the general government sector is discussed in Annex 2.

3

NON-FINANCIAL CORPORATE

AND HOUSEHOLD SECTORS

C H A P T E R 3

25NBS


C H A P T E R 3

Chart 25 Output, sales and investment (index: same period of the previous year = 100)

Source: SO SR.

Chart 23 Investments of non-financial corporations and households (index: same period of the previous year = 100)

Source: Eurostat, SO SR.

Chart 24 Outstanding loans to non-financial corporations and households(EUR billions)

Source: NBS.

120

110

100

90

80

70

60

Non-financial corporationsHouseholds

2008 2009 2010 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

16

15

14

13

12

11

10

HouseholdsNon-financial corporations

2009 2010

140

120

100

80

60

Industry salesInvestments of non-financial corporationsIndustrial output

2006 2007 2009 2010 2005 2008

3 NON-FINANCIAL CORPORATE AND HOUSEHOLD SECTORS

The domestic banking sector’s financing of non-financial corporations (enterprises) and house-holds picked up in 2010, although the situation in lending to enterprises was relatively heterogene-ous. Lending growth was most pronounced in the second half of the year, when banks also increased their lending to non-financial corporations. Lend-ing growth to households increased in 2010, with the new loans comprising mainly housing loans and to a lesser extent consumer loans.

3.1 NON-FINANCIAL CORPORATE SECTOR

The majority of business confidence indicatorsreturned to pre-crisis levels.

The upturn in sentiment was maintained in the sectors of industry, services, and retail trade. In the construction sector, by contrast, the business climate assessments remained pessimistic. The majority of other short-term indicators also sug-gest a continuation of the economic recovery.

26NBS


C H A P T E R 3

Chart 26 Business tendency indicators

Source: Eurostat.

Chart 27 Financing of non-financialcorporations by instrument (EUR billions)


Chart 28 Financing of non-financialcorpations by sector (EUR billions)


40

20

0

-20

-40

-60

IndustryConstruction

Retail tradeServices

2008 2009 2010

7

6

5

4

3

2

1

0

-1

-2

-3

-4

-5

-6

-7Q4 2008 Q1 2009

Debt securitiesEquitiesOthersNet financial assets

LoansCommercial loansLiabilities

Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010

7

6

5

4

3

2

1

0

-1

-2Q4

2008Q1

Financial institutionsHouseholdsLiabilities

Non-financial corporationsGeneral governmentRest of the world

Q2 Q3 Q4 Q1 Q2 Q3 Q4 2009 2010

As the economy recovered, profitability returnedto growth.

The overall profits of non-financial corporationsrose by 30.4% in comparison with 2009, to €8,590 million. The largest share of total profits was re-corded by enterprises in the sectors of manu-facturing, electricity and gas supply, and trade. With the business environment becoming more

conducive to the implementation of investment plans, there was a revival in investment activity and borrowing demand.

Non-financial corporations reduced their indebt-edness.

As a result of the economic crisis, corporate bal-ance sheets had to be adjusted. Non-financialcorporations faced increasing difficulty in ob-taining external financing, and this was reflect-ed in a decline in the sector’s debt-to-GDP ratio as well as in its ratio of its liabilities to financialassets.

As regards the financing structure of non-finan-cial corporations, an increasing proportion of their funding was obtained through the issuance of market instruments, mainly equity securities. Debt financing was lower than in the past, as en-terprises opted for debt security issues and com-mercial loans and reduced their loan liabilities. However, the enterprises that are able to raise fi-nance from diverse sources are mainly large cor-porates and firms under international ownership.Small and medium-sized enterprises are depend-ent on loans to a greater extent. Compared with the previous year, a smaller proportion of funds were borrowed from creditors in the domestic economy, mainly financial institutions. The shareof inter-corporate lending increased.

27NBS


C H A P T E R 3

Chart 29 Savings rate and investment rate (% of GDI)

Source SO SR, NBS calculations. 1) Year-on-year changes.2) Not including pension funds.Note: GDI – gross disposable incomesavings rate and investment rate – annualised.

Chart 30 Unemployment and job vacancy rates (%)

Source: SO SR.Note: Job vacancy rate = number of job vacancies / (number of occupied posts + number of job vacancies).

14

12

10

8

6

4

2

0

-2

GDI1)

Investment rateSaving rateSaving rate2)

2008 2009 2010 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

20

16

12

8

4

2008

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0

2009 2010Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Q3 Q4Q3 Q4

Job vacancy rate (rhs) Unemployment rate

3.2 HOUSEHOLD SECTOR

The economic situation of households in 2010 was affected by the sluggish improvement in thelabour market and by the stagnation of dispos-able income.

Consumer confidence recovered to some extentin the first half of 2010, only to slide back againin the second half of the year amid rising fears about the country’s projected economic situa-tion and about the future financial position ofhouseholds. The situation in the labour market improved modestly as the year wore on; the un-employment rate declined and the supply of job vacancies rose slightly.

The gross disposable income of households stagnated. As for primary income, a crucial ele-ment in the repayment of household liabilities, it recorded a slighter higher rate of growth. After rising during the recession period, the house-hold savings ratio stopped increasing in 2010. Households were cautious in their investment decisions, as the stagnation of the investment ra-tio indicated. In a low-inflation environment, themodest rise in nominal wages passed through to a small increase in real wage growth.

Household indebtedness

The accumulation of savings in 2009 was affect-ed by the slower rate of borrowing, as measured by the ratio of liabilities to financial assets. At thesame time, however, the moderation of disposa-ble income growth caused a deterioration in the ratio of liabilities to gross disposable income.

The ability of households to service their debts (li-abilities) on a regular basis was satisfactory at the aggregate level, with the ratio of loan repayment liabilities to disposable income standing at 26%.

The increase in financial assets was lower thanin 2009. As regards the structure of household financial assets, the proportion of higher-risk as-sets began rising again, as their rates of return rebounded. The amount of term deposits also increased, mainly in the second half of the year.

A proportion of households took advantage of low interest rates to refinance debts taken onin the past. In the second half of the year there was also an increase in new lending. With inter-est rates falling, households had an incentive to make greater use of longer interest rate fixationperiods. The cautious approach of households to consumption expenditure was accompanied by a lower demand for consumer loans.

28NBS


C H A P T E R 3

Chart 31 Household debt ratios (%)

Source: SO SR, Eurostat.

Chart 32 Household financial assets1) (EUR billions)

Source: Eurostat. 1) Households and non-profit institutions serving households.Note: Cumulative transactions over four quarters.

100

80

60

40

20

0

Liabilities/GDP Liabilities/financial assets

2005 2007

Liabilities/gross disposable income

20082006 2009200420032002

9

8

7

6

5

4

3

2

1

0

-1

-2

Currency in circulationDebt securitiesMutual fundsOther Net financial assets

DepositsEquities Insurance Assets

Q42008

Q1 Q2 Q3 Q42009

Q1 Q2 Q3 Q42010

3.3 MEDIUM-TERM RISK IN THE NON-FINANCIAL CORPORATE AND HOUSEHOLD SECTORS

Since the banking sector is focused on lending to non-financial corporations and households, banksare highly exposed to credit risk on such loans.

The medium-term risks relate mainly to:• the financial position of non-financial

enterprises focused on the domestic economy;

• the budgetary strains of indebted house-holds;

• consumer demand slackening due to the repercussions of fiscal measures onhousehold disposable income.

Medium-term risks persist in the non-financialcorporate and household sectors.

Exported-oriented non-financial corporations were able to generate balance-sheet profits

and reserves in 2010. As for enterprises fo-cused on the domestic economy, their posi-tion remains difficult owing to low consumer demand.

Although the household sector balance sheet in 2010 did not represent a significant risk to finan-cial stability, the fact that the domestic banking sector is increasing its credit exposure to house-holds may in future make it more susceptible to household credit risk.

The labour market has yet to recover to the ex-tent necessary to bring about an improvement in the financial position of households. It ap-peared in 2010 that households still lacked ca-pacity to accumulate savings, given the stagna-tion in disposable income growth and the need to cover necessary expenditure. If household income growth fails to accelerate, low consumer demand may continue to subdue profits in thoseindustries that depend on domestic household consumption.

FINANCIAL SECTOR

DEVELOPMENTS AND RISKS

C H A P T E R 4

4

30NBS


C H A P T E R 4

Chart 33 Amount of assets or managed assets by financial market segment (EURbillions)

Source: NBS.

Chart 34 Housing loans to households (EUR billions; %)

Source: NBS.

70

60

50

40

30

20

10

0

December 2008June 2009

Insurers SPMCsInvestment funds

Investment firms

PFMCs

December 2009June 2010

December 2010

Banks

12

10

8

6

4

2

0

Change in housing loans outstanding (rhs)Housing loans outstanding

20102008 2009

35

30

25

20

15

10

5

0

(EUR billions) (%)

4 FINANCIAL SECTOR DEVELOPMENTS AND RISKS

Conditions in the Slovak financial sector weremore benign in 2010 than in 2009. This was re-flected in the amount of assets managed by in-stitutions regulated by Národná banka Slovenska which increased year-on-year by 5.1%, to €72.7 billion. The highest annual growth was reported by pension funds and collective investment funds (Chart 33). Asset growth in the banking sector picked up again in 2010, after declining sharply in 2009 due to the impact of the economic crisis and the changeover to the euro (an outflow of surplusshort-term deposits of foreign banks). The pace of growth in banking sector assets in 2010 lagged far behind its levels recorded from 2005 to 2008. Prof-its in the financial sector showed a year-on-yearimprovement in 2010. The only exception was the insurance sector, whose profits fell slightly in year-on-year terms.

4.1 THE BANKING SECTOR

In 2010, the profitability of the banking sec-tor as measured by return on equity (ROE) was twice as high as in 2009, when the sector’s profitsslumped. Even so, the profitability of the bank-

ing sector in 2010 remained far below its pre-cri-sis levels. The sector was more heavily oriented on households, and the increasing competition among banks was reflected in both their lendingand deposit-taking activities. Corporate financ-ing stagnated and banks preferred investment in securities, mainly those issued by governments. Stress testing confirmed significant resilienceof the banking sector to shocks. Corporate risks still dominate, although certain banks reported a higher sensitivity also in respect of loans to households.

4.1.1 MAJOR TRENDS IN THE BANKING SECTOR BALANCE SHEET

Housing finance market recovered in the courseof 2010.

The further acceleration in the housing loan growth was driven by a considerable increase in the amount of new loans (Charts 34 and 35). In early 2010, the substantial rise in new loans was only moderately reflected in the stock of loans asthe new loans were predominantly used for refi-nancing old loans while interest rates were low.

31NBS


C H A P T E R 4

Chart 35 New mortgage loans and other housing loans (EUR millions)

Source: NBS.

Chart 36 Interest rates on new housing loans (%)

Source: NBS.

Chart 37 Credit standards for loans to households

Source: NBS.Note: Data are given as a net percentage share, with a positive value indicating an easing of standards. Changes in standards express the subjective view of banks.

250

200

150

100

50

0

Mortgage loans Other housing loans

20062005 20082007 2009 2010

7.0

6.5

6.0

5.5

5.0

4.5

4.0

Housing loansMortgage loansBuilding loansIntermediary loansOther house purchase loansEURIBOR 1Y (right-hand scale)

20102009

2.5

2.0

1.5

1.0

0.5

0

60

40

20

0

-20

-40

-60

-80

Actual values in the given half-yearValues expected in the next half-year

House purchase loans Consumer and other loans

1H 2

009

2H 2

009

1H 2

010

2H 2

010

1H 2

009

2H 2

009

1H 2

010

2H 2

010

Supported by favourable conditions, the refinanc-ing trend continued in the second half of 2010, but the amount of new housing loans for the di-rect purchase of property started to increase more significantly. This was reflected in the increasednumber of transactions for new apartments, par-ticularly in the last quarter of 2010.

Intense competition among banks translated into lower interest rates, while the easing of credit standards supported customer demand for new housing loans.

The average weighted interest rate for the bank-ing sector fell relatively sharply, even as inter-bank rates went up in the same period (Chart 36). This development was inconsistent with the rate-setting behaviour of banks over the long term. Competition among banks for customers thus intensified in the second half of 2010, whichwas reflected in the loosening of standards forcollateral.18 The easing of lending standards for loans to households had a more general char-acter in the second half of the year (Chart 37). Competition among banks intensified, probablybecause those banks that had lost market share during the crisis in the first half of 2009 begantrying to claw it back as soon as the macroeco-nomic situation stabilised. The behaviour of cus-tomers also changed, as they became far more

discriminating between the different interestrates offered by different banking groups.

Increased competition among banks was also reflected in household deposits whose structurechanged in favour of term deposits with longer maturities.

18 Several banks increased the amount of new loans that have a loan-to-value (LTV) ratio of between 80 % and 100 %.

32NBS


C H A P T E R 4

Chart 38 Household (resident) deposits in the banking sector (EUR billions)

Source: NBS.

Chart 39 Interest rates on new household deposits (%)

Source: NBS.

Chart 40 Comparison of sales in selected sectors with 2008 (index: Dec. 2008 = 100%)

Source: SO SR.

12

10

8

6

4

2

0

Demand depositsDaily term depositsTerm deposits up to 1 yearLong term depositsTotal household deposits (rhs)

20102009

22.00

21.50

21.00

20.50

20.00

19.55

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

Demand depositsDaily term deposits Term deposits up to 1 yearTerm deposits over 1 yearEURIBOR 1Y

20102009

130

120

110

100

90

80

70

December 2009

Indu

stry

Cons

truct

ion

Sale

of m

otor

vehi

cles

Who

lesa

le tr

ade

Reta

il tra

de

Hote

ls

Rest

aura

nts

Sele

cted

mar

ket

serv

ices

Tele

com

mun

icat

ions

Tran

spor

tatio

nan

d st

orag

e

December 2010

In 2010, bank customers were attracted to term deposits with a longer interest rate fixation pe-riod (Chart 38). By contrast, demand for term de-posits with an agreed maturity of up to one year had a declining trend. A substantial increase was seen in a new segment of term deposits – over-night deposits – dominated by one smaller bank. These changes in the structure of term deposits resulted from rising competition among banks as reflected in their interest rate policies. The rise indeposit rates was substantial and it occurred be-fore the increase in interbank market rates (Chart 39). Similarly to loans, this behaviour was incon-sistent with the long-term behaviour of banks in setting household deposit rates. The main gain-ers from the sector’s growth in the second half of the year were small banks, which saw their mar-ket share approach that of medium-sized banks.

The improvement in the economic situation of firms in 2010 had little effect on their demand forloans, which may also relate to a rise in corporate financing from abroad. The approach of domes-tic banks to corporate loans remained cautious: the total amount of loans further stagnated.

Reflecting the macroeconomic upturn in 2010,several sectors reported higher sales. Only a few sectors, however, saw a return to pre-cri-sis levels (Chart 40). A decline in spare capacity in industry created conditions for higher de-

mand for further sources of financing. The risein demand for corporate loans was counterbal-anced by tendency to replace, in corporate bal-ance sheets, external financing by own fundsfrom abroad.19 The result was a partial revival in loan demand from large firms as well as smalland medium-sized enterprises. On the other hand, bank credit standards were only slightly modified, and remained tight at the end of 2010

19 This deleveraging was a way of repairing balance sheets impaired by the financial crisis.

33NBS


C H A P T E R 4

Chart 41 Credit standards for new loans to enterprises

Source: NBS.Note: Data are given as a net percentage share, with a positive value indicating an easing of standards. Changes in standards express the subjective view of banks.

Chart 42 Loans to enterprises (EUR billions; %)

Source: NBS.

60

40

20

0

-20

-40

-60

-80

-100

Actual values in the given half-yearValues expected in the next half-year

Loans to enterprises in total

Short-term loans

to enterprises

Long-term loans

to enterprises

Loans to SMEs

Loans to large enterprises

1H 2

009

2H 2

009

1H 2

010

2H 2

010

1H 2

009

2H 2

009

1H 2

010

2H 2

010

1H 2

009

2H 2

009

1H 2

010

2H 2

010

1H 2

009

2H 2

009

1H 2

010

2H 2

010

1H 2

009

2H 2

009

1H 2

010

2H 2

010

16

12

8

4

0

-4

-8

Amount of loans (lhs)Growth in loans – totalGrowth in loans – up to 1YGrowth in loans – from 1Y to 5YGrowth in loans – over 5Y

40

30

20

10

0

-10

-20

(%)(EUR billions)

2007 2008 2009 2010

(Chart 41). As a result, the total amount of loans to enterprises rose by only 0.4% in 2010, thus stagnating for the second consecutive year (Chart 42). In 2010, banks also remained cau-tious about supplying housing loans, which be-fore the outbreak of the crisis had been among

the fastest-growing segments in loans to non-financial corporations.20

Corporate deposits remained flat. Within corpo-rate financial assets, the amount of assets invest-ed abroad climbed.

The amount of corporate deposits has remained almost unchanged in 2010. As a share of total corporate financial assets, the amount of assetsinvested abroad climbed from 16% to 20%. These investments predominantly comprised loans to non-residents, probably as intra-group transac-tions. As for movements in corporate demand for deposit accounts, it can be interpreted from the long-term view as a consequence of changes in the liquidity management of groups to which domestic enterprises belong.

The amount of loans provided to non-resident enterprises increased in 2010, whereas loans to financial intermediaries further declined.

Almost solely in the first two months of 2010,a significant rise in the amount of loans to for-eign corporates was registered. However, only certain banks were involved in these develop-ments. The negative trend in loans to other fi-nancial intermediaries continued. By the end of 2010, the stock of loans to financial intermediar-ies was at the level reported in the first half of2004. The situation among banks, however, was relatively heterogeneous.

To compensate for stagnating corporate loans, banks invested in securities, mainly governments bonds. A small number of banks held bonds is-sued by countries with high sovereign risk. The decline in the market value of selected bonds has not so far had a major effect on the banking sec-tor’s profitability.

Securities investments by banks increased main-ly during 2009. The sharp increase of investments in government bonds in some banks can be ex-plained by attractive interest rate differentialsbetween government bonds and funds from the Eurosystem. Purchases of securities continued over the first half of 2010. In the second half of2010, banks did little more than maintain their security holdings (Chart 43). In the sector’s port-folio of purchased securities, government bonds accounted for 90% of the real value of the securi-

20 In 2008, the credit portfolio recorded year-on-year growth of 33%, but in 2010 it rose by only 3.6%.

34NBS


C H A P T E R 4

Chart 43 Changes in the amount of securities in banks‘ portfolios (EUR millions)

Source: NBS.

Chart 44 Foreign debt securities as a share of total bonds by country as at 31/12/2010 (%)

Source: NBS.

Chart 45 Selected interbank assets and liabilities (EUR billions)

Source: NBS.

1,000

800

600

400

200

0

-200

-400

-600

-800

-1,000Feb. 2010

Foreign government bondsDomestic government bondsTotal securities

Feb. 2009 June 2009 June 2010Oct. 2009 Oct. 2010

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0Greece Netherlands Italy Other Hungary Poland Ireland

16151413121110

9876543210

Bills of exchange – residents (incl. held to maturity)Funds from the ECB and other foreign issuing banksFunds from other resident banksFunds from other non-resident banksOperations with the ESCB and foreign central banksOperations with other non-resident banksTreasury bills – resident (incl. held to maturity)

2008 2009 2010

ties and they consisted mainly of Slovak govern-ment bonds. There were also a significant propor-tion of bonds issued by Greece, Poland, Hungary, Ireland and Italy (Chart 44). The majority of these bonds were, however, held by a limited number of banks. As regards the portfolio breakdown, a majority (54%) of bonds were recorded in the portfolio of securities held to maturity and 35% were in available-for-sale portfolio. Thus, in 2010, only a negligible proportion of bonds were re-valued at fair value through profit and loss. Theseinvestments may result in considerable losses for the given banks if risky countries restructure their debt. Markets are becoming increasingly concerned that some highly indebted countries (Greece and Portugal) may not be able to reduce their debt, given that their economies have se-rious structural problems and therefore cannot grow at a fast enough pace.

The most prevalent transactions in the domestic interbank market remained transactions with non-resident banks, in particular intra-group transac-tions. The average maturity of interbank assets and liabilities continued to be relatively short.

Interbank liabilities and assets were relatively volatile in 2010, as they had been in the past. The largest changes in the total amount took place in funds from non-resident banks (Chart 45). It

remained the case in 2010 that a significant pro-portion of transactions with non-resident banks (on both the asset and liability sides) were intra-group transactions. Banks used funds from the interbank market mainly for investment in more liquid assets (investments in the interbank mar-ket, investments in debt securities or Treasury bills, short-term loans to enterprises and general

35NBS


C H A P T E R 4

Chart 46 Distribution of ROE in the banking sector (%)

Source: NBS.Note: The Chart shows the median, weighted average, interquartile range, and the minimum and maximum ROE values for individual banks. The Chart does not include branches of foreign banks.

Chart 47 Main components of profitability(EUR millions)

Source: NBS.Note: Net provisions and reserves include the net gain on the as-signment to third parties of claims on customers.

December 2008 December 2010December 2009

Net interest income from

retail loans

Net income from fees/commissions

for retail transactions

Net interest income from other loans

Net income from fees/commissions

for other transactions

Net interest incomefrom securities

Other non-interestprofit/loss

Operating expenses

Net creation of provisions and reserves

0 200 400 600 800 1,000 1,200 1,400

50

40

30

20

10

0

-10

-20

-30

-40

-50

-60

-70

-80

-90Dec. 2007 Dec. 2009 Dec. 2010Dec. 2008

Weighted average Median

government) or as a means of offsetting devel-opments in more volatile liabilities (short-term deposits from the general government and from enterprises). This means that even in a liquid-ity crisis (as during the global financial crisis) inwhich banks would be unable to obtain funds from non-resident banks, the functioning of most banks in Slovakia would probably not be serious-ly jeopardised. Banks prefer more stabile domes-tic sources for financing longer-term assets.

4.1.2 PROFITABILITY

The banking sector’s net profit as at 31 December2010 was 100% higher year-on-year, after plung-ing by 50% in 2009. The retail sector made the largest contribution to this rise. Profitability con-tinued to differ greatly between individual banks.

The median ROE returned almost to the pre-crisis level recorded in 2007 and 2008 (Chart 46). Nev-ertheless, the interquartile spread expressing the heterogeneity of profitability in the banking sec-tor remains relatively large. The sector’s net profitof €504 million as at 31 December 2010 did not, however, reflect losses from the revaluation ofsecurities in the portfolio of financial instrumentsavailable for sale, which were relatively significantin certain banks in 2010. These losses were taken

into account in the so-called comprehensive fi-nancial result.21 In 2010, they amounted to 13% of the reported profit, largely due to the negativerevaluation of portfolio holdings of government bonds issued by higher-risk countries. The profitof the sector was mainly supported by retail trans-actions – both interest and non-interest income from these transactions increased (Chart 47). Banks profited from the growth in retail lendingand also from falling costs of retail deposits. Banks also reported a rise in income from investments in securities, largely due to an increase in the volume of debt securities. Another key factor of profitabil-ity in 2010 was the fall in provisioning costs. The trend decline in the ratio of provisions to non-per-forming loans reached around 73% in 2010.

4.1.3 CAPITAL REQUIREMENTS

Own funds in the sector increased more slowly in 2010 than in 2009. There was a rise in the high-est-quality component of banks’ own funds, and the upturn in lending activity was reflectedin an increase in risk-weighted assets. This had a downward effect on the capital adequacy ratioof the sector.

The total amount of own funds in the bank-ing sector increased by 4.0% year-on-year. The

21 ‚Comprehensive financial result‘ isdefined as the net financial resultless valuation differences adjustedfor current taxes. Valuation differ-ences express the changes in the real values of securities held in the portfolio of financial instrumentsfor sale, which led to changes in equity in 2010, without affectingthe reported financial result.Although valuation differenceswould affect the financial result atthe time when the securities are sold, it is recommended, given the possibility of their sale in the near future, to monitor their potential impact on the financial result.

36NBS


C H A P T E R 4

Chart 48 Capital position of the banking sector (EUR billions; %)

Source: NBS.Note: CAR = capital adequacy ratio.

Chart 49 Ratio of non-performing household loans (%)

Source: NBS.

5.0

4.0

3.0

2.0

1.0

0.0

Tier 1Tier 2Tier 3Minimum CAR (rhs)Average CAR (rhs)

24

20

16

12

8

4

0

(%)

2005 2007 20082006 2009 2010

(EUR billions) 25

20

15

10

5

0

MaximumMedian

Weighted averageMinimum

20102009Feb.

growth in own funds in 2010 represented only 47% of the amount of the increase in 2009. The slower rise in own funds was mainly related to the fact that profits in 2009 were lower than inthe previous years and that the situation in fi-nancial markets was somewhat calmer following the global financial crisis. The increase recordedduring the first six months of 2010 comprisedmainly a rise in the highest-quality component (Tier 1), drawn mainly from retained earnings from previous years (Chart 48). In the second half of the year, own funds were increased using lower-quality Tier 2 capital in the form of subor-dinated debt. The slight rise in own funds and substantial increase in risk-weighted assets had a downward effect on the capital adequacy ratioin the second half of 2010. In June of that year, the CAR stood at 13.1%, but by December it had fallen to 12.7% (Chart 48). The Tier 1 capital ra-tio for the banking sector was 11.5% at the end of 2010 (compared to 11.4% a year earlier). The lowest Tier 1 ratio reported by any bank in the sector at the end of 2010 was 7.2%.

4.1.4 RISKS IN THE BANKING SECTOR

The financial position of households was im-proved in 2010, as the period of low interest rates enabled households to reduce their in-terest rate burden. This, in combination with an upturn in the labour market and recovering

economic growth, contributed to the easing of household credit risk. On the other hand, this risk may increase in the future due to changes in the structure of unemployment that disadvantage higher-income households and to rising inter-est rates. Although conditions for improving corporate credit risk persisted in 2010, this risk remained significant for banks due to the size ofbanks’ exposures to firms, the relatively heavyconcentration of loans, and the high sensitivity of firms to economic developments. Corporatecredit risk remains the most significant risk inthe banking sector. Liquidity risk in the banking sector was largely unchanged in 2010 and the short-term and long-term liquidity indicators were in positive territory. The most significant ofthe market risks in the banking sector is the risk of the effect of interest rate movements on thebanking book.

4.1.4.1 Household credit risk

The credit risk of households eased during the course of 2010.

The increase in non-performing household loans reported by the banking sector in 2010 was sub-stantially lower than in 2009. The ratio of non-performing household loans declined as well (Chart 49). This positive development was partly

37NBS


C H A P T E R 4

Chart 50 Increases in the number of unemployed

Source: Central Office of Labour Social Affairs and Family.

Chart 51 Share of new housing loans by LTV ratio (%)

Source: NBS.Note: LTV – the ratio of the amount of a loan to value of the col-lateral provided for it.

12,000

10,000

8,000

6,000

4,000

2,000

0

Higher income categoryMiddle income categoryLower income category

2007 2009 20102008

50

40

30

20

10

0

Up to 60% From 60% to 80%

Apr. June

Over 80%

JulyMay Aug. Oct. Nov.Sep. Dec.Mar.Feb.Jan.

attributable to the sale or write-off of non-per-forming loans.

The decline in household credit risk stemmed mainly from the improving economic situation, labour market stabilisation and low interest rates.

The debt servicing ability of households was positively influenced by the improving situa-tion in employment. In industry, the sector with the most employees, the employment trend re-mained positive as a consequence of the upturn in the global economy. In this sector, as well as in the trade sector, further employment growth is assumed. By contrast, employment in sectors oriented on the domestic economy (particularly construction, services, and the public sector) is expected to decline. Although unemployment growth stabilised over 2010, however, its struc-ture underwent a change towards the year-end (Chart 50). Rising unemployed in the higher-income categories is seen as a negative factor in terms of credit risk, since the majority of the outstanding amount of loans is concentrated in the middle- and higher-income categories. As in-terest rates declined and loans with a short inter-est rate fixation period retained a high share intotal loans, customers were able to reduce their overall interest repayment burden. From the end

of 2009 and during 2010, many customers refi-nanced an old loan by taking out a new loan un-der a more favourable interest rate.

The rise in household credit risk in the near term may be driven by a potential increase in interest rates and by excessive loosening of bank credit standards due to increased competition.

The expected rise in interest rates will create up-ward pressure on credit risk. The risk of a rise in customer rates will be subdued by the fact that the vast majority of interest rates on new loans arranged in 2010 had a longer fixation periodand by increased bank competition in lending. Where, however, rising competition leads to an excessive loosening of lending conditions (inter-est rates that are inappropriate for the quality of the customer; high LTV ratio), it increases the risk of losses from lending (Chart 51).

4.1.4.2 Credit risk of non-financial corporations

The positive trends in many business sectors passed through to decelerating growth of non-performing loans.

For the first time since the onset of the crisis, thepace of growth of non-performing loans to enter-prises slowed as, in the last two months of 2010,

38NBS


C H A P T E R 4

Chart 52 Non-performing loan ratio in the corporate sector and year-on-year change in the amount of non-performing loans to enterprises (%)

Source: NBS.

15

10

5

0

-5

-10

Ratio of non-performing loansChanges in the outstanding amount of non-performing loans

Jan.

200

9Fe

b. 2

009

Mar

. 200

9Ap

r. 20

09M

ay 2

009

June

200

9Ju

ly 2

009

Aug.

200

9Se

p. 2

009

Oct

. 200

9No

v. 2

009

Dec

. 200

9Ja

n. 2

010

Feb.

201

0M

ar. 2

010

Apr.

2010

May

201

0Ju

ne 2

010

July

201

0Au

g. 2

010

Sep.

201

0O

ct. 2

010

Nov.

201

0D

ec. 2

010

several banks began purging their portfolios of bad loans (Chart 52), mostly by selling them and to a lesser extent by writing them off. While thistrend appeared in loans to most sectors, it was particularly pronounced in the sectors of trans-portation, chemical industry, wholesale trade and real estate.

The economic upturn contributed to a reduction in corporate credit risk.

The gradual recovery of the global economy favoured mainly the export-oriented domestic firms. This was reflected in their sales growthand in an overall improvement in business con-fidence. Expectations for continuing growth inindustrial activity are also supported by a rise in new orders.

Loans arranged for the construction of commer-cial properties continue to be a significant sourceof credit risk.

This segment, which was the fastest growing before the crisis, remains a significant source ofcredit risk for the banking sector. The reason lies not only in the high level of exposure to this seg-ment and its elevated concentration, but also in the fact that commercial property market has

weak transparency and very low liquidity. The of-fice segment stabilised to some extent in 2010,as amid unchanging prices and constant supply of office space, the office vacancy ratio graduallydeclined. Nevertheless, the office segment re-mains highly sensitive, particularly due to strong market concentration on both the supply and demand sides. The residential segment also re-corded a slight improvement in the last quarter, when the number of sold apartments increased and their overall supply fell. The main problem remains the still high number of projects that are struggling to sell apartments.

4.1.4.3 Liquidity risk

The long term liquidity position of the banking sector was favourable and stable in 2010. The short-term liquidity of the sector was equally sta-ble and reported the required levels.

The loan-to-deposit ratio remained favourable in 2010, at below 100% (Chart 53). It remained large-ly unchanged during the year, due to stagnation in corporate lending. In the household sector, the trend of loans increasing by a greater margin than deposits continued. Should this trend continue in the medium-term horizon, domestic resources for the financing of loans will be exhausted, thusincreasing the banks’ dependence on financialmarkets. Although the current maturity mismatch between assets and liabilities became more pro-nounced in several banks, it is positive, in terms of the banking sector resilience, that most banks are still managing to finance long-term loans withcustomer deposits. The mortgage bonds issued by banks22 have an appreciable role in this regard, since they increase the diversification and stabil-ity of loan funding. The ratio of fixed and illiquidassets reported a positive development and re-mained comfortably below the limit of 100% dur-ing 2010 (Chart 53).23 The liquid asset ratio was stable during 2010 (Chart 54).24 In general, larger banks continued to report the lower ratios.

4.1.4.4 Market risks

The most significant risk to the banking sectoras a whole has remained interest rate risk in the banking book.

The interest rate risk in the banking book is the risk that net interest income gradually falls in the

22 As at the end of 2010, mortgage bonds constituted more than 91% of the total amount of securities issued by banks.

23 The ratio of fixed and illiquid assetsis defined as the ratio of fixed andilliquid assets to selected own funds items. Its level should not rise above 100%.

24 The liquid asset ratio is defined asthe ratio of liquid assets to volatile liabilities over a horizon of one month. Its level should not fall below 100% (or 1).

39NBS


C H A P T E R 4

Chart 53 Long-term liquidity ratio of the banking sector (%)

Source: NBS.

Chart 54 Liquid asset ratio of the banking sector

Source: NBS.

100

80

60

40

20

0

Loan-to-deposit ratioFixed and illiquid assets ratioLoan-to-deposit ratio incl. mortgage bondsLoan-to-deposit ratio of households

2009 2010

3.0

2.5

2.0

1.5

1.0

0.5

0Dec.2009

Jan. July

Quartile rangeMedian

Aug.Feb. Mar. Apr. May June

Average

Nov. Dec.Sep. Oct.2010

event that interest rates rise (since interest rate fixation periods are shorter on the liability sidethan on the asset side of bank balance sheets). The impact of this risk on banks‘ profitability isamplified by the fact that banks are having to in-crease interest rate spreads due to stronger com-petition. The results of macro stress testing (see Part 4.5) indicate that in the case of almost all banks, a raising of interest rates would contrib-ute to a reduction in their net profit, assumingthat the banks keep their interest rate policies unchanged when reacting to movements in the yield curve.25 The exposure of banks to interest rate risk in the banking book remained largely unchanged during the second half of 2010. Al-though the average fixation period for interestrates on customer transactions became longer, it did so to around the same extent for loans and deposits.

Interest rate risk in the trading book remained low in all banks, largely due to the small size of the trading books.

The ratio of trading book assets and liabilities to total assets and liabilities was only 2.0% and 2.9%, respectively. In the event of a parallel rise in interest rates of 2 percentage points, the overall loss of the banking sector would thus be around 0.14% of own funds, and no bank should make a loss of more than 6% of own funds.

The general interest rate risk was relatively low in banking book portfolios revalued at fair value through profit and loss or own funds.

The bulk of banking book assets and liabilities are not revalued at fair value; this, however, does not apply to equity and debt securities that banks hold in their portfolios of financial instru-ments available-for-sale and financial instru-ments revalued at fair value through profit andloss (not including those held for trading).26 The exposure of the banking sector as a whole to the risk of losses in the two mentioned portfolios was relatively low as at 31 December 2010. Were interest rates to increase in parallel by 2 percent-age points, the overall loss would stand at 6% of own funds.

Only certain banks in the Slovak banking sector are significantly exposed to counterparty risk.

Only a few banks are significantly exposed tocounterparty risk, i.e. the risk that securities will drop in value owing to a decline in the issuer’s (counterparty) credit quality. These are banks that invested heavily in highly risky government bonds issued by certain euro area countries (Table 3). As banks hold these assets mostly in portfolios that are not revalued at fair value, their profitabil-ity and own funds were not significantly affectedwhen the prices of these bonds fell sharply in

25 These results also reckon on a partial decline in the amount of loans, resulting from the assumed rise in interest rates.

26 At present, the revaluation of avail-able-for-sale financial instrumentsis not recorded in the profit andloss account, as the respective securities are still held by the bank. Own funds are reduced only by a downward revaluation of equity securities. The revaluation of finan-cial instruments included in the second of the portfolios mentioned has a direct effect on the value ofthe reported profit or loss, and inthe case of a downward revalua-tion, also on the level of own funds.

40NBS


C H A P T E R 4

Table 3 Investments in debt securities of selected countries as a share of total assets (%)

Greece Hungary Ireland Italy Spain Portugal

BanksVI.10 1.1 0.7 0.1 0.1 0.1XII.10 1.1 0.6 0.2 0.2 0.1 0.1

SPMC fundsVI.10 0.1 0.8 1.3 0.5 0.7XII.10 0.1 0.9 0.6 0.8 0.8

PFMC fundsVI.10 0.9 1.4 1.6 0.2 4.5XII.10 0.3 2.1 1.9 0.4

Investment funds

VI.10 0.3 1.6 0.8 0.6XII.10 0.2 1.4 0.3 0.5 0.1 0.1

InsurersVI.10 0.1 0.1 0.1 2.3 0.2XII.10 0.1 0.1 0.2 2.6 0.2

Unit-linked insurance

VI.10XII.10 0.3

Source: NBS.Note: Values represent debt securities issued by the respective country, or institutions established in that country, as a share of total assets or NAV. Where a cell of the Table is left empty, it means that the respective values are zero or negligible.

Chart 55 Total profits of insurancecompanies (EUR millions) (%)

Source: NBS.

250

200

150

100

50

02005 2006 2007 2008 2009 2010

2010. However, the own funds of some banks would be significantly affected if those bonds inthe held-to-maturity portfolio were revalued due to a decline in the issuer’s credit quality.27

The exposure of the banking sector to equity risk and foreign exchange risk is negligible.

Investments in equities and investment fund shares/units as a proportion of the balance sheet total remain negligible in a majority of banks. As regards open foreign-exchange positions, all banks also have a low exposure to foreign exchange risk.

4.2 THE INSURANCE SECTOR

4.2.1 FINANCIAL POSITION OF THE INSURANCE SECTOR

In 2010, life insurance was on the rise and profitsin the non-life insurance sector fell sharply.

Total profits in the insurance sector in 2010 amounted to €133.7 million, representing a strong rise of 2.9% in comparison with the previous year (Chart 55). The result was largely attributable to a single insurance company. If the effect of this insurer‘s result is excluded, the sector‘s overall profit climbed by more than one-third. More than half of the insur-ers saw a year-on-year improvement in their financial results. Profits from financial opera-tions rose by 1.1%. A positive contribution was also made by the results of insurance activi-

ties in life insurance. However, these positive aspects were outweighed by unfavourable results in non-life insurance. Although techni-cal costs recorded a year-on-year decline (ow-ing to the marked increase in the participation of reinsurers in insurance claims), the profits from insurance activities in non-life insurance came to only around half the level of the previ-ous year. The profits in the non-life insurance sector declined as a result of lower premiums, higher reinsurance and a drop in other techni-cal income.

27 In economic terms, it cannot be ruled out that the debts of these countries‘ will be restructured, de-spite the financial assistance theyhave received from the European Financial Stability Fund (EFSF), which is due to be terminated in 2013.

41NBS


C H A P T E R 4

Chart 56 The guaranteed interest rate in comparison with the actual return (%)

Source: NBS.

5

4

3

2

1

02006

The average guaranteed interest rate in life insuranceThe investment return on assets covering technical reserves in life insuranceThe return on 10-year Slovak government bonds

2007 2008 2009 2010

4.2.2 RISKS IN THE INSURANCE SECTOR

For insurance companies, the most significantrisk is that of a persisting period of low interest rates.

The risk of persisting low interest rates, especially on longer maturities, is mostly connected with life insurance. An environment of low interest rates makes it difficult for life insurers to generatereturns on the assets that make up the respective reserves at least at the level of the guaranteed interest rate (Chart 56). This risk is associated above all with the necessity of accepting a lower return when reinvesting funds obtained from maturing financial instruments. Insurers mitigatethe above-mentioned risk by transferring market risks to customers through investment insurance products – i.e. unit-linked insurance.

Among the other main risks to the insurance sec-tor are a weakening of the economy, the effect ofcompetition on the calculation of premiums in motor third-party liability insurance, the concen-tration of claims on a single counterparty, and interest rate risk.

For the insurance sector, any further weakening of the economy represents a downside risk to its outlook for new insurance contracts and upside risk to its outlook for surrender rates. While this

may not necessarily mean a loss to an insurer (if the surrender value is set low), it could disrupt the insurer’s business strategy aimed at securing an appropriate balance-sheet structure and risk profile. Other risks to the financial position of in-surance sector results lie in the persisting strong competition in motor third-party liability insur-ance (MTPL) and the high value of the combined ratio in certain sectors. Motor insurance (MTPL and motor vehicle insurance) together with the property insurance segment account for al-most 83.2% of non-life insurance by amount of premiums. Heightened competition is putting downward pressure on prices (which are not re-flecting the expense ratio in these sectors)28 and it is therefore squeezing the profitability of insur-ance activity. The risk of a concentration of ex-posure to a single specific counterparty is mostpronounced in several smaller insurance compa-nies. The relatively long duration of the debt se-curities portfolio (which increased slightly even during 2010 – Table 4), together with the high share of securities revalued at fair value, helped ensure that rates of return on assets remained solid even during the period of low interest rates and financial market turbulences. While an in-crease in rates would cause a downward revalua-tion of these securities, such a scenario would also bring down the value of liabilities. The ulti-mate effect is difficult to quantify. The insurancesector‘s exposure to other market risks – equity risk, foreign-exchange risk, and the risk of a drop in the value of bonds owing to a decline in the issuer’s credit quality – is relatively small (Table 4). Only a few insurance companies would be af-fected to a significant degree.

4.3 THE COLLECTIVE INVESTMENT SECTOR

The net asset value of mutual funds increased rapidly during the first half of 2010 and thenmore slowly in the second half.

The net asset value of mutual funds sold in Slo-vakia increased by 9.1% in 2010, to €4.5 billion. (Chart 57). Net sales of funds and the perform-ance of funds were at their highest in the firstfour months of the year, continung the positive trend recorded in the second half of 2009. Dur-ing the next two months, the value of net sales was around zero and the value of certain assets decreased, as global financial markets were af-

28 Main expense ratios in non-life insurance (loss ratio and combined ratio) reached in 2010 their highest values for more than ten years.

42NBS


C H A P T E R 4

Table 4 Share of equity, foreign-exchange and interest-rate positions in different sectors of thefinancial market (%)

Banks InsurersPFMC funds

SPMC funds

Investment funds

Unit-linked insurance

Equities and investment fund shares / units

XII.09 0.2 2.6 0.1 4.7 17.6 80.8XII.10 3.8 0.1 20.3 19.1 81.2

Foreign-exchange positions

XII.09 0.4 0.9 0.1 4.9 12.5 12.9XII.10 1.5 0.1 12.2 11.2 13.9

Debt securitiesXII.09 28.3 63.1 68.0 70.8 51.8 17.2XII.10 26.5 68.2 68.5 66.0 46.3 17.4

Duration of debt securities

XII.09 2.7 5.7 0.5 2.1 1.1 5.9XII.10 3.0 6.1 0.4 3.2 1.2 5.5

Duration of entire portfolio

XII.10 5.7 0.4 2.1 0.6 1.0

Residual maturity of debt securities

XII.09 2.8 7.8 0.8 3.0 1.8 6.2XII.10 3.8 7.8 0.4 3.8 1.7 5.1

Source: NBS.Note: Values are given as a percentage share of assets or NAV and they represent the asset-weighted average for the given group of institutions. Durations and residual maturities are given in years. Foreign exchange positions were calculated as the sum of the absolute values of the posi-tions for each institution. Equity positions do not include participating interests in subsidiaries and affiliates.

Chart 57 Net asset value of mutual funds marketed in Slovakia (EUR billions)

Source: NBS.

6

5

4

3

2

1

0

Domestic asset management companiesForeign asset management companies

Dec. 2006 Dec. 2007 Dec. 2008 Dec. 2009 Dec. 2010

0.8 0.930.5 0.7 0.73

3.52

4.44

3.293.42

3.77

fected by major turbulences related to the Greek debt crisis. The net asset value began to grow again over the subsequent period, albeit at a far slower pace than at the beginning of the year.

Asset structures in different mutual fund catego-ries underwent only a small change in 2010.

In money market funds, the trend of selling bonds and reinvesting the proceeds in term ac-

counts continued. Equity funds, too, followed on from 2009 in raising the share of investments in equities and mutual fund shares/units, at the ex-pense of other, more conservative asset compo-nents. In real estate funds, participating interests in real estate companies increased as a share of the asset portfolio. The changes in other catego-ries were minimal.

The returns on mutual funds decreased in 2010 as compared with 2009, although in some cases this reflected the very sharp depreciation record-ed by the mutual funds in 2008.

The performance of mutual fund returned to a standard level in 2010, after fluctuating wildly in2008 and 2009 amid the global financial crisis andsubsequent recovery of financial markets. By farthe average highest rate of return in 2010 was in equity funds, at 16.5% (Chart 58). That figure waseven slightly higher than the appreciation of the benchmark S&P 500 equity index. In terms of per-formance over a three-year horizon, however, equi-ty funds, mixed funds, and funds of funds remain in negative territory, having still not wiped out all the losses incurred at the peak of the financial crisis.

The most significant risk for mutual funds contin-ues to be equity risk.

Collective investment funds were sensitive to any return of rising uncertainty in financial markets.

43NBS


C H A P T E R 4

Chart 58 Average returns on mutual funds by fund category (% p.a.)

Source: NBS.Note: Average return weighted by net asset value.

December 2009 December 2010

Money market

Bond

Equity

Mixed

Funds of funds

Other

Real estate

-5 0 5 10 15 20 25 30 35 40

Chart 59 Structure of funds‘ assets by main instruments (%)

Source: NBS.

120

100

80

60

40

20

0

-20

-40

LiabilitiesOther assetsEquities and mutual fund shares / unitsTreasury billsBondsBank accounts

Dec. 2007 Dec. 2008 Jún 2009 Jún 2010Dec. 2009 Dec. 2010

This is caused by an increased exposure of funds to equity risk. Several funds have a relatively high net foreign exchange position, caused by unhedged positions in financial instrumentsdenominated in non-euro currencies. The credit risk of issuers related to investments in bonds is a majority of funds relatively low.

4.4 THE PENSION SAVING SECTOR

Pillar II

The amount of assets managed by PFMCs in-creased in 2010 due to regular contributions of savers and minimum fluctuations in the valua-tion of funds assets. Pension funds continued to make very conservative investments.

The net asset value in Pillar II of the pension sav-ing system reached €3.72 billion. The share of particular asset classes owned by PFMC barely changed at all and the funds retained a con-servative structure that kept fluctuations inperformance to a minimum (Chart 59). Pension funds invested in bonds, Treasury bills and bank deposits. After being heavily sold in the previous year, equities accounted for an almost negligible proportion of the net asset value during the year not exceeding 0.13% and falling to less than half

of that value before the end of December. Assets denominated in foreign currency had minimal share in the asset structure of funds (Table 4), and at no point during the year did this share ex-ceed 0.5% in any of the funds.

Savers lack a genuine choice between conserva-tive, balanced and growth funds.

In the second half of 2009, the differences be-tween the asset structure of each type of fund almost completely disappeared in all PFMCs. This situation persisted throughout 2010, not only at the level of the basic distribution of assets be-tween different investment types, but also inregard to the specific choice of particular securi-ties. Thus, a saver who is deciding between the different funds offered by a given PFMC cannotin fact choose one that has a risk-return profilemost suitable for his requirements. Moreover, the asset structure of funds of different PFMCsalso converged to some extent during 2010.

Exposure to sovereign debt securities of higher-risk euro area countries declined during 2010.

Towards the end of 2010, PFMCs reduced their exposure to government bonds issued by Greece, Ireland, Portugal and Spain, which de-clined as a share of the sector’s net asset value to

44NBS


C H A P T E R 4

Chart 60 Current value of pension units by type of fund

Source: NBS.

0.039

0.038

0.037

0.036

0.035

0.034

0.033

Balanced

Mar

. 200

5

Sep.

200

5

Ma r

. 200

6

Sep.

200

6

Ma r

. 200

7

Sep.

200

7

Ma r

. 200

8

Sep.

200

8

Ma r

. 200

9

Sep.

200

9

Ma r

. 201

0

Sep.

201

0

Growth Conservative

Table 5 Annual rate of return on pension funds as at 31 December 2010 (%)

Min Weighted average Max

Conservative funds 0.8 1.2 1.9

Balanced funds 0.8 1.2 1.9

Growth funds 0.8 1.2 1.9

Source: NBS.Note: The average annual return on pension funds is calculated as a weighted average of the year-on-year percentage changes in the daily values of pension fund units of the respective pension funds.

around 2% as at the year-end, from a relatively high level of 11% as at 31 December 2009. The bulk of these positions were closed naturally, through the maturing of these securities. Of those securities that were sold, only one bond is-sue was traded at a substantial discount (due to its higher residual maturity. At the end of 2010, Slovak government bonds accounted for almost 53% of all the sector’s government securities, or 27% of the overall net asset value. The stability of the whole portfolio of PFMC funds is therefore heavily dependent on the value of Slovak gov-ernment bonds remaining stable.

The performance of Pillar II funds in 2010 corre-sponded to their asset structure and it was nega-tive in real terms. Pension funds have been re-cording low returns since they began operation.

Since funds were not exposed to equity markets and held interest-sensitive instruments of short duration, the current values of pension units recorded linear growth and almost no volatility during the course of 2010 (Chart 60). As a re-sult, the year-on-year performance stabilised at a constant level, and the weighted average for each of the three types of fund was the same, 1.2%, as at 31 December 2010. Such a return was not enough to cover inflation rate for 2010,which, as measured by the Harmonised Index of Consumer Prices, reached 1.3%. Looking at fund performance over the long-term (since the cur-rent system came into being), it is conservative funds that have achieved the highest average annualised return (of around 2.8%); the reper-cussions of the financial crisis were less severe onconservative funds than on the other two types. The average annualised return on balance and growth pension funds over the same period was only 1.4% and 1.0%, respectively.

The conservative asset structure of PFMC funds was also reflected in the low risk of losses.

For PFMC funds, the risks of asset value impair-ment are low, given the very conservative struc-ture of their portfolios. The most significant riskin the portfolio of PFMC funds is that the issu-ers of certain government securities held in the portfolio suffer a deterioration in credit quality.This risk, however, concerns the funds of a single company and it is limited by the short maturity of the respective bonds and Treasury bills. As at 31 December 2010, PFMC funds did not have any holdings of Greek government bonds.

The vulnerability of Pillar II funds was increased by their relatively high concentration in bank ac-counts.

The relatively low diversification of bank depositsalso contributed to counterparty risk. The median value for the share of the largest counterparties in NAVs was 9%. The risk that one of the counter-parties would default was relatively low. In most

45NBS


C H A P T E R 4

cases, these deposits are held directly in Slovak banks (approximately half of the total volume), or they are held in banks that are part of banking groups which have a subsidiary or branch in Slo-vakia. The risk was also mitigated by the short re-sidual maturity period of term deposits, which as at 31 December 2010 was around three months and did not exceed one year in any fund.

Pillar III

The more or less linear increase in the net value of assets under management in the sector con-tinued in 2010. As regards asset class structu-re, the most significant change in 2010 was therapid rise in the share of investments in equities and mutual funds. The overall changes in the portfolio of Pillar III funds has made them more sensitive to movements in equity indices, interest rates and foreign exchange rates.

The net asset value in Pillar III of the pension sav-ing system reached €1.15 billion at the end of September 2010. The growth in net asset value recorded by each SPMC was close to the sectoral average of 9%.

During 2010, the largest component of fund as-sets at the sectoral level was bonds, but their share fell to 67%. The duration of the bond port-folio underwent a relatively substantial increase (from 2.1 years to 3.2 years). The trend decline in the amount of funds held with banks in current and term accounts continued. Bank deposits ac-counted for as much as one-half of fund assets at the end of 2007; at the end of 2010 they only ac-counted for 13%. The most significant change inthe portfolio was the rapid rise in the share of eq-uities and investment funds. As at 31 December 2010, their share stood at 20%, making them the second largest asset class in funds, after bonds, while in previous periods their share had not exceeded 5%. The inclusion of a large volume of equities and mutual fund shares/units in the portfolio contributed substantially to the rise in the proportion of assets denominated in foreign currencies. The amount of foreign exchange as-sets more than quadrupled during the year, to stand at 13% of the net asset value of funds in the sector. The rise in foreign currency assets was accompanied by a more intensive utilisation of currency derivatives in order to reduce open for-eign exchange positions.

Only certain SPMC funds were exposed to securi-ties issued by higher-risk countries.

At the end of 2010, investments in securities is-sued by high-risk countries accounted for 3.2% of the sector‘s NAV. In comparison with PFMC funds, however, this risk is much greater owing to the high residual maturity of these bonds, at 5.1 years.

Although funds undertook a greater degree of risk, their performance did not improve as a result.

In the case of both payout and contributory funds, the average annual return fell year-on-year, to 1.5% and 1.9%, respectively, as at 31 De-cember 2010. While the performance of payout funds declined only slightly, the return on con-tributory funds as a group was only around a half of the return made in 2009. The lowest return re-corded by any fund was 0.2%.

4.5 MACRO STRESS TESTING

As at the end of 2010, the banking sector again re-ported relatively strong resilience to unfavourable macroeconomic scenarios due to its initially strong capital position and its ability to make a profit, es-pecially through net interest income.29 The Cost-Push Inflation scenario would be expected to havea negative effect on the banking sector.

Macro stress testing is used to give a fuller pic-ture of the risk profile of different sectors orfinancial corporations. Since this is a compre-hensive estimate of developments in the finan-cial sector, one requiring a fairly large number of assumptions (Table 6), the results are used more for purposes of comparison than as an ab-solute quantification of potential profits/lossesunder particular scenarios. The testing involved designing two stress scenarios and comparing them with a third, baseline scenario. Scenario 1, “the Sovereign Crisis scenario”, is based on the risk that public finances in certain euro areacountries are unsustainable. An important de-velopment of this scenario is the negative spill-over effects on other countries. Scenario 2, „theCost-Push Inflation scenario“, envisages a rise incommodity prices influenced by an expansivemonetary policy of the US Federal Reserve. The stress testing period comprises the years 2011

29 A detailed description of scenarios, assumptions and stress testing parameters can be found in The Analysis of the Slovak Financial Sector for 2010, published by the NBS in April 2011 http://www.nbs.sk/_img/Documents/_Dohlad/ORM/Analyzy/2010-1a.pdf

http://www.nbs.sk/_img/Documents/_Dohlad/ORM/Analyzy/2010-1a.pdf



46NBS


C H A P T E R 4

Table 6 Stress testing parameters

Baseline scenario Sovereign Crisis Cost-Push Inflation

Q4 2011 Q4 2012 Q4 2011 Q4 2012 Q4 2011 Q4 2012

Baseline assumptions External demand (year-on-year change) 5.30 % 6.82 % -10.00 % 6.00 % -10.00 % 5.56 %USD/EUR (year-on-year change) 0 % 0 % -40 % 24 % 0 % 0 %Exchange rates of CHF, JPY, GBP, DKK, CAD, HRK, LVL against EUR (year-on-year change)

0 % 0 % -40 % 24 % 0 % 0 %

Exchange rates of other currencies against EUR (year-on-year change)

0 % 0 % 40 % -24 % 30 % -12 %

Equity prices (year-on-year change) 10 % 10 % -40 % 24 % -30 % 28,57 %ECB base rate (year-on-year change) 0 b.b. 0 b.b. 0 b.b. 0 b.b. 200 b.b. 0 b.b.3-month EURIBOR (year-on-year change) 47 b.b. 34 b.b. 116 b.b. -12 b.b. 305 b.b. 27 b.b.iTraxx index (year-on-year change) 0 b.b. 0 b.b. 105 b.b. -84 b.b. 105 b.b. -84 b.b.Rise in credit spreads on debt issued by GR and IE 0 b.b. 0 b.b. 315 b.b. -252 b.b. 315 b.b. -252 b.b.Rise in credit spreads on debt issued by ES, IT and PT

0 b.b. 0 b.b. 210 b.b. -168 b.b. 210 b.b. -168 b.b.

Macroeconomic variables estimated using a model

GDP growth (year-on-year change) 2.75 % 5.07 % -6.86 % 5.40 % -5.54 % 4.19 %Inflation (HICP) 4.34 % 2.72 % 2.02 % -1.61 % 8.13 % -0.30 %Unemployment 14.13% 13.69 % 15.17 % 16.17 % 14.97 % 15.97 %

Variables for credit risk estimated using macroeconomic variables

Annual probability of default

1.35 % 1.69 % 1.92 % 3.74 % 2.21 % 3.61 % 7.9%2.02 % 2.20 % 2.92 % 5.99 % 2.70 % 6.27 % 15.5%4.65 % 4.70 % 6.36 % 8.38 % 6.32 % 10.22 % 24.8%

Ratio of non-performing household loans 5.46 % 4.96 % 6.08 % 6.08 % 8.01 % 7.22 %Source: NBS.

Table 7 Impact of stress scenarios on banking sector capital adequacy (%)

Lower quartile Median

Average weighted by amount of risk-weighted

assets

Upper quartile

As at 31 December 2010 11.2 12.2 12.7 15.1As at 31 December 2010 after the addition of net profit

12.5 13.4 13.6 16.5

Baseline scenario (2011) 12.2 13.9 14.5 17.6Baseline scenario (2012) 13.6 14.7 15.9 19.1Sovereign Crisis (2011) 11.4 13.1 13.8 17.4Sovereign Crisis (2012) 11.5 14.0 14.5 18.5Cost-Push Inflation (2011) 11.0 12.6 13.3 17.0Cost-Push Inflation (2012) 11.0 13.5 13.8 17.9Source: NBS.

and 2012. Branches of foreign banks were ex-cluded from the calculation. The banking sec-tor at the end of 2010, as under previous stress tests, reported relatively strong resilience to un-favourable macroeconomic scenarios (Table 7). This was largely due to two factors: the sector‘s strong initial capital position and its ability to make a profit, especially through net interest in-come. So although four banks would make a net loss in 2011 and 2012 under the Sovereign Crisis scenario and six banks would do so under the

Cost-Push Inflation scenario, a majority of thesebanks would comfortably meet the 8 % capital adequacy requirement in each year. 30

The most significant risk for banks remains cor-porate credit risk. Depending on the scenario, however, certain banks would record higher losses from household credit risk than from cor-porate credit risk. Losses from market risks would be marginal, except in a few banks where they would have greater impact.

30 When quantifying the impact of particular scenarios on the capital adequacy ratios of banks, it was not envisaged that any euro area country or other country would default. As a consequence, only debt securities in the trading book or available-for-sale portfolio were revalued at fair value.

47NBS


C H A P T E R 4

Chart 61 Simulated losses from credit risk and market risks in the banking sector (EUR millions)

Source: NBS.

200

100

0

-100

-200

-300

-400

-500

-600

Losses from corporate credit riskLosses from household credit riskOverall net losses from the revaluation of securities and interest rate derivativesOverall net losses from foreign exchange transactionsOverall net losses from equity securities

2011

Sovereign Crisis Cost-Push Inflation Baseline scenario

2012 2011 2012 2011 2012

Chart 62 Impact of stress scenarios on PFMC funds (index: December 2010 = 1)

Source: NBS.Note: The left-hand scale shows the current value of the pension unit index (weighted by the net asset value of individual funds).

1.10

1.05

1.00

0.95

0.90

Baseline scenarioSovereign CrisisCost-Push Inflation

Jan.

200

8

July

2008

Jan.

200

9

July

2009

Jan.

201

0

July

2010

Jan.

201

1

July

2011

Jan.

201

2

July

2012

The sector‘s largest losses under particular sce-narios are from corporate credit risk. However, the weight of household credit risk has increased. The largest losses in the retail loan portfolio would be incurred under the Cost-Push Inflationscenario; in several banks, this loss would exceed the loss from non-performing loans. Under each of the scenarios, corporate credit risk is related to the fact that the default rate on corporate loans is highly sensitive to GDP developments. As for household loans, their default rate reflects theimpact of inflation and the related effect of in-terest rates. Losses from foreign-exchange and equity risks would continue to have a marginal effect (Chart 61).

Banks‘ losses arising from different types of riskwould be mitigated mainly by net interest in-come and a strong initial capital position.

The resilience of the banking sector as at the end of 2010 was largely determined by its initially strong capital position and its ability to make a profit, especially through net inter-est income. Although four banks would make a net loss in 2011 and 2012 under the Sover-eign Crisis scenario and six banks would do so under the Cost-Push Inflation scenario, a ma-jority of these banks would comfortably meet the 8% capital adequacy requirement in each

year due to having a strong capital position at the outset.

Under a rise in interest rates as assumed in the stress scenarios, PFMC funds would increase their returns.

Given the structure of their portfolios, PFMC funds are not sensitive to a decline in equity prices or to exchange rate movements, nor, in the major-ity of cases, to an increase in the credit spreads of bonds issued by high-risk countries. For the over-all portfolio of PFMC funds, the average residual period of interest rate fixation is only five months,and therefore the stress scenarios would have almost no effect on the returns on a majority ofPFMC funds. After the end of this period, the rate of return would even rise owing to the growth in interest income amid rising interest rates, as as-sumed in the stress scenarios (Chart 62).

SPMC contributory funds would make relatively large losses under the stress scenarios.

Since SPMC funds have a significant exposure,particularly to equity risk and interest rate risk, they would record a comparatively sharp drop in the pension unit value under both stress scenar-ios (Chart 63). The largest losses would be seen in growth funds under the Sovereign Crisis sce-

48NBS


C H A P T E R 4

Chart 63 Impact of stress scenarios on SPMC funds (index: December 2010 = 1)

Source: NBS.Note: The left-hand scale shows the current value of the pen-sion unit index (weighted by the net asset value of individual funds).

1.10

1.05

1.00

0.95

0.90

Contributory funds – Baseline scenarioContributory funds – Sovereign CrisisContributory funds – Cost-Push Inflation Payout funds – Baseline scenarioPayout funds – Sovereign CrisisPayout funds – Cost-Push Inflation

July 2009 Jan. 2011 July 2012July 2010 Jan. 2012Jan. 2010 July 2011

Chart 64 Impact of stress scenarios on collective investment funds (%)

Source: NBS.Note: The left-hand scale shows the estimated gain/loss as a share of the net asset value (weighted by the net asset value of individ-ual funds).

Chart 65 Impact of stress scenarios on insurers‘ assets (%)

Source: NBS.Note: The left-hand scale shows the estimated gain/loss as a share of assets except for assets covering technical provisions in unit-linked insurance (weighted by the asset value of individual insur-ance companies). The effect of stress scenarios on the value ofliabilities was not taken into account.

4

3

2

1

0

-1

-2

Net gain on revaluation – Baseline scenarioNet gain on revaluation – Sovereign CrisisNet gain on revaluation - Cost-Push Inflation Net interest income

Jan.

201

1Fe

b. 2

011

Ma r

. 201

1Ap

r. 20

11M

ay 2

011

June

201

1Ju

ly 2 0

11Au

g. 2

011

Sep.

201

1Oc

t. 20

11No

v. 20

11De

c. 20

11Ja

n. 2

012

Feb.

201

2M

ar. 2

012

Apr.

2012

May

201

2Ju

ne 2

012

July

2 012

Aug.

201

2Se

p. 2

012

Oct.

2112

Nov.

2012

Dec.

2012

6

4

2

0

-2

-4

-6

Baseline scenarioSovereign CrisisCost-Push Inflation

Dec.

2010

Jan.

201

1Fe

b. 2

011

Mar

. 201

1Ap

r. 20

11M

ay 2

011

June

201

1Ju

ly 20

11Au

g. 2

011

Sep.

201

1Oc

t. 20

11No

v. 20

11De

c. 20

11Ja

n. 2

012

Feb.

201

2M

ar. 2

012

Apr.

2012

May

201

2Ju

ne 2

012

July

2012

Aug.

201

2Se

p. 2

012

Okt.

2112

Nov.

2012

Dec.

2012

nario, owing to a substantial fall in equity prices (by approximately 15% to 20% of NAV).

The results of stress testing of the collective in-vestment sector are influenced by the high pro-portion of less risky funds.

Investment funds would not make substantial losses under the „Sovereign Crisis“ scenario (Chart 64), because money market funds and bond funds constitute a large proportion of all funds in terms of their share in the overall net asset value. At the same time, losses caused by a fall in equity prices in riskier funds would be partially offset by theassumed strengthening of the US dollar against the euro, the currency in which these investment funds have open foreign-exchange positions. Un-der the Cost-Push Inflation scenario, this effect ofan appreciating dollar is absent and the losses, on average, would therefore be greater.

Insurance companies would cover any negative revaluation of assets with interest income.

As for insurers, their interest income would be practically unaffected for all scenarios within thestress testing horizon, given that the debt secu-rities portfolio, as the main part of insurers‘ as-sets, has a relatively long duration. This interest

income would, moreover, be sufficient to coverany losses from the revaluation of assets that may take place under the stress scenarios (Chart 65).

THE TARGET2-SK AND EURO SIPS

PAYMENT SYSTEMS – SECURITY AND

RELIABILITY IN 2010

C H A P T E R 5

5

50NBS


C H A P T E R 5

Chart 66 Volume of payments processed in TARGET2-SK (thousands)

Source: NBS.

Chart 67 Value of payments processed in TARGET2-SK (EUR billions)

Source: NBS.

15.0

12.5

10.0

7.5

5.0

2.5

0.0

20102009

Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec.

180

160

140

120

100

80

60

40

20

0

20102009

Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec.

5 THE TARGET2-SK AND EURO SIPS PAYMENT SYSTEMS – SECURITY AND RELIABILITY IN 2010

The TARGET2-SK payment system was put into operation in Slovakia on 1 January 2009, the same date on which the country adopted the euro. From the view of financial stability risks,the system performed well in 2010, without any impairment.

Upon joining the euro area on 1 January 2009, Slovakia became connected to the TARGET2 payment system and Národná banka Slovenska started operating its component of this system – TARGET2-SK. The second year of the TARGET2-SK payment system’s operation can be judged to have been successful and free of problems. No incidents were recorded, regarding either the system itself or its participants, which would jeopardise the smooth processing of payments or disrupt the system’s operation. Apart from being responsible for the system’s daily opera-tion, for providing its participants with consul-tation and business support, and for regular testing of recovery procedures, Národná banka Slovenska is involved in coordinating the devel-opment, modification, testing and implementa-tion of software releases for the single shared

platform (SSP) that forms the technical basis of TARGET2. It is through new releases of this soft-ware that new functionalities and modifications(approved by the Eurosystem at the request of the system‘s participants) are implemented in the SSP and that bugs identified in the previ-ous release are removed. The 2010 SSP release introduced internet-based access to TARGET2 without requiring a connection to the SWIFT network, previously the only means of access-ing the system.

The number and value of transactions executed in the TARGET2-SK system in 2010 decreased year-on-year.

A total of 33 participants were connected to the TARGET2-SK payment system in 2010. Of that number, 30 were direct participants (including Národná banka Slovenska) and three were an-cillary systems – EURO SIPS, Centrálny depozitár cenných papierov SR, a.s. (CDCP – the central securities depository), and First Data Slovakia, a.s. Almost 150,000 transactions with an overall value of more than €682.2 billion were execut-

51NBS


C H A P T E R 5

Chart 68 Structure of payments sent by TARGET2-SK participants in 2010 (%)

Source: NBS.

Domestic – 37%Cross-border – 63%

Domestic

Cross-border

Volume of payments Value of payments

Domestic

Cross-border

Domestic – 61%Cross-border – 39%

ed in the TARGET2-SK payment system in 2010. In comparison with 2009, the number of trans-actions fell slightly, by 3.4% (Chart 66), and the value of transactions declined by 22.6% year. The disparity is caused by the unusually large amounts of payments made in January 2009, probably influenced by the euro changeover(Chart 67).

The value of interbank payments in TARGET2-SK was substantially higher than the value of customer payments, while the value of domestic payments exceeded the value of cross-border payments.

As for the payments processed in 2010 and their breakdown into customer and interbank trans-actions, customer payments have the slightly higher share by number (56:44) while interbank payments have the overwhelmingly larger share by value (96:4). Of the total number of payments made by TARGET2-SK participants in 2010, 37% were domestic transactions and 63% were cross-border transactions. As regards the value of such payments, however, the ratio is almost exactly the opposite (Chart 68).

The EURO SIPS retail payment system satisfies allthe required principles of functionality, security and reliability.

EURO SIPS is a retail payment system for the processing and clearing of customer payments in euro; it is an ancillary system using the trans-European TARGET2-SK payment system. Pay-ment transactions are processed in EURO SIPS in clearing cycles and their results are financiallysettled in TARGET2-SK. Since 1 January 2009, in-terbank transactions have been processed and settled exclusively in TARGET2-SK. In connec-tion with the implementation of SEPA payment instruments in Slovakia, the EURO SIPS payment system will be made compatible with the Single European Payments Area (SEPA) by the end of 2012. During 2010, Národná banka Slovenska assessed the EURO SIPS system in compliance with a Eurosystem requirement for countries en-tering the euro area. When assessed against the „Core Principles“ for retail payment systems, EUR SIPS was found to be fully compliant with the re-quired principles.

The number and value of transactions executed in EURO SIPS in 2010 increased year-on-year.

The EURO SIPS retail payment system had 30 participants in 2010. A total of 162,796,000 transactions were processed in EURO SIPS, corresponding to a trend increase of almost 5% over recent years (Chart 69). The value of the transactions amounted to €164,590.1 mil-

52NBS


C H A P T E R 5

Chart 69 Volume of transactions executed in EURO SIPS (millions)

Source: NBS.

Chart 70 Value of transactions executed in EURO SIPS (EUR billions)

Source: NBS.

16

14

12

10

8

6

4

2

0Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec.

2007 2008 2009 2010

340

320

300

280

260

240

220

200

180

160

140

120

100

80

60

40

20

0

20

18

16

14

12

10

8

6

4

2

0Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec.

20072009 (Right-hand scale)

20082010 (Right-hand scale)

lion, representing a rise of 6.5% year-on-year; However, this followed a sharp fall in the value of transactions executed in EURO SIPS in 2009

resulting from the migration of large-volume transactions to the TARGET2-SK system (Chart 70).

ANNEXES

THE VIEWS AND RESULTS EXPRESSED IN THE ANNEXES

ARE THOSE OF THE AUTHORS AND DO NOT NECESSARILY

REFLECT THOSE OF NÁRODNÁ BANKA SLOVENSKA

54NBS


A N N E X 1

Table 8 Recovery of outlays and net direct cost of financial sector support (% of 2009 GDP)

Direct supportNet direct cost

Pledged Utilised Recovery

G-20 average 4.0 2.2 0.4 1.8Advanced economies 6.2 3.5 0.8 2.8

In billions of USD 1,976 1,114 237 877Emerging economies 0.8 0.3 - 0.3

In billions of USD 108 43 - 43Source: IMF, “A fair and substantial contribution by the financial sector – final report for the G-20”, June 2010.Note: The direct fiscal cost is the sum of recapitalisations, asset purchases and borrowings from public funds.

Chart 71 Public debt (% of GDP)

Source: IMF, World Economic Outlook, April 2011.Note: Data for the years 2011 to 2016 are forecasts.

120

100

80

60

40

20

0

Advanced economiesWorld

Emerging and developing economiesG7

2000 2002 2004 2006 2008 2010 2012 2014 2016

1 EFFECTIVE TAXATION OF THE FINANCIAL SECTOR

TOMÁŠ TŐZSÉR

Modern finance can seriously jeopardise thefinancial stability of countries, a fact all too evi-dently confirmed by the recent global financialand economic crisis. For a sustainable long-term solution, it is necessary to change the approach to financial sector regulation and to redesigngovernment safety nets.31 Alongside the ongo-ing global changes in these areas, a number of countries – mainly those whose public financeshave been most heavily burdened by bailouts of insolvent banks – are starting to impose addi-tional taxes and levies on financial corporations.The main aim in this regard is to recover at least part of the public funds expended on the rescue of private banks. Another benefit of additionaltaxation of the financial sector may be, however,that it strengthens financial stability through theabove-mentioned changes in safety nets. In this paper, we examine the most effective methodsof additional taxation of financial institutions forboth purposes.

THE NET DIRECT COST OF RESCUING FINANCIAL INSTITUTIONS WAS RELATIVELY SMALL, BUT THE INDIRECT COST OF THE FINANCIAL CRISIS HAS BEEN CONSIDERABLE

The International Monetary Fund (IMF) has esti-mated that the average net fiscal cost of directsupport to the financial sector in the G-20 ad-vanced countries as at the end of 2009 amounted to 2.8% of GDP (Table 8). According to Deutsche Bank, the final direct cost of taxpayer support forfinancial sectors will in most advanced countriesnot exceed 1% of GDP.32 Although the direct fis-cal costs of bank rescue measures may in the end

be relatively low in comparison with the amount of public funds originally set aside for financialsector bailouts, the indirect costs for taxpayers are very high. Indirect cost arise, for example, from lower tax revenues and higher government spending as a result of crisis-induced recession, but they also include higher debt servicing costs resulting from increases in interest rates and debt levels. The IMF estimates that the public debt-to-GDP ratio for the G-20 advanced countries in the period 2008–2015 will soar by almost 40 percent-age points – with much of that increase attribut-able to the crisis. It is clear that the repercussions

31 Alessandri, P., Haldane, A.G., “Bank-ing on the state”, Bank of England, November (2009).

32 Schildbach, J., “Direct fiscal cost ofthe financial crisis”, Deutsche BankResearch, 14 May (2010).

55NBS


A N N E X 1

Chart 72 Fiscal balance (% of GDP)

Source: IMF, World Economic Outlook, April 2011.Note: Data for the years 2011 to 2016 are forecasts.

2

0

-2

-4

-6

-8

-10

Advanced economiesWorld

Emerging and developing economies

2000 2002 2004 2006 2008 2010 2012 2014 2016

of the financial crisis for the real economy, andespecially for public finances, will be long termin character (Charts 1 and 2).

TAXATION OF FINANCIAL INSTITUTIONS – A USEFUL TOOL OF PRUDENTIAL POLICY33

Taxes and levies are commonly used to address externalities in the areas of environmental pro-tection, health, and security. Nevertheless, the various market failures in the financial interme-diation sector (asymmetry of information, ex-ternalities from restricted provision of collateral, excessive volatility in financial markets) are dealtwith almost entirely through financial regulation.This applies mainly to the prudential regulation of individual institutions (micro-prudential regu-lation). The financial crisis has sharpened theneed for high-quality macro-prudential regula-tion of the financial sector (where the focus is onsystemic risk). This is an endogenous risk of the financial system arising from the procyclical be-haviour of banks and it is also related to the pres-ence of large and complex financial institutions.Basel III, the refined global regulatory standardfor banks, is also focused in this direction − it in-troduces a counter-cyclical capital surcharge and additional capital requirements for systemically important financial institutions. The changes infinancial regulation concern a range of other

areas (bank liquidity, remuneration, accounting standards, etc.).34 The failure of supervision and financial regulation vis-à-vis the containmentof systemic risk, and the considerable damage done to public finances as a result, has given riseto calls for the deployment of taxes as a tool of prudential policy in the financial sector.

In a theoretical world, without uncertainty and with complete information, taxation and regu-lation would be equivalent tools in the task of containing systemic risk. In practice, however, the imposition of taxes is more advantageous. For example, a corrective tax may be levied directly on a financial institution’s activity that is deemedsocially undesirable due to being a source of systemic risk. Achieving the equivalent effectthrough a capital surcharge would require an esti-mation of the bank’s cost of capital,35 which can be complicated as the cost of capital varies over time and across institutions. Also, the costs that taxes impose on banks are smoother and more contin-uous than those imposed by capital surcharges. From the view of the state, taxes have a consid-erable advantage in that they create fiscal spaceand help reduce the fiscal impact of bank failures,especially if a resolution framework for banks is in place. Imposing taxes or levies is also simpler, fast-er and less costly than the (unavoidable) introduc-tion of harmonised regulation of those financialinstitutions and activities which have up to now not been covered by regulation (so-called shadow banking).36 Another unquestionable advantage of taxation is that it is non-discriminatory in nature, in contrast to the well-known problems of the po-litical economy related to regulatory decisions on taking preventive measures during a boom.

On the other hand, addressing system risk through capital surcharges has an advantage over taxation in that it can rely on better inter-national coordination, since there is already a global regulatory standard and international framework in the form of the Basel Committee for Banking Supervision. Capital surcharges in-crease the buffer against losses and therefore,unlike taxes, directly reduce the probability of bank failure, which is particularly important in the case of systemically important institutions. Furthermore, capital surcharges have stronger corrective effects when taxes cannot be maderisk-sensitive enough. In such case, taxation could even be counterproductive.

33 This part draws heavily from the IMF publication “A fair and sub-stantial contribution by financialsector – final report for the G-20,June 2010”.

34 For further details, see, for example, the Financial Stability Board publication “Progress in the Imple-mentation of the G20 Recommen-dations for Strengthening Financial Stability” (February 2010), available at http://www.financialstability-board.org/publications/r_110219.pdf

35 Capital surcharge * cost of capital = tax.

36 For example, the lengthy prepara-tions and implementation within the Basel III framework of counter-cyclical capital surcharges and additional capital requirements for systemically important financialinstitutions. These measures are not expected to be implemented until 2019. Banks need a relatively long period to adjust to the new regulatory regime, given the scope of the changes and the financialcosts they will involve.

http://www.financialstabilityboard.org/publications/r_110219.pdf



56NBS


A N N E X 1

Table 9 European bank levies

Rate Taxable base Start date

Estimated receipts

Belgium 0.15%Bank deposits to households and similar insurance products

2010 €700m annually

Germany

0.02% for a base of less than €10bn; 0.03% for a base that is more than €10bn but less than €100bn; and 0.04% for a base of more than €100bn

Liabilities of German banks adjusted for capital and deposits of non-bank institutions

2011 Approx. €1bn

France 0.25% Minimum capital requirement 2011 €555m in 2012

Austria

0.055% for a base that is more than €1bn but less than €20bn, increas-ing to 0.085% for a base of more than €20bn; derivatives will face a levy of 0.013% of nominal value

Liabilities of Austrian banks less equity and insured deposits

2011 €500m annually

Denmark Capped at 0.2% of liabilities Covered deposits and securities 2011 -

Hungary0,15% for a base of less than Ft50bn, increasing to 0.53% for a base above this limit

Hungarian banking assets adjusted for domestic interbank loans and securities issued by other domestic financial corporations

2010, 2011

€670 million

Sweden0.036% but reduced to 0.018% during 2009 and 2010

Banks’ liabilities less equity and subor-dinated debt

2009€250 million

annually

United Kingdom

0.075%

Liabilities less insured deposits, capital, and repo transactions secured with government bonds or bonds issued by supranational institutions (the IMF, etc.)

2011 €3bn in 2012

Source: FT Reporters, “European states braced for tax backlash”,www.ft.com, 11 January 2011.Laznia, M., “Systém krízového riadenie bank: nástrahy návrh”, Biatec, April 2011.

For completeness, it must be added that regulato-ry and tax policies share certain similar drawbacks. These include incidence (the question of who bears the final burden), perimeter (the set of firmsto be taxed or regulated), calibration (assessing the benefits and costs/undesirable effects), andinternational coordination (important at present in regard to the effectiveness of measures).

Overall, the discussion suggests that the taxation of banks may be a useful complement to macro-prudential regulation.

AN UNEVEN APPROACH TO THE TAXATION OF FINANCIAL INSTITUTIONS IN THE EU

The G-20 meeting in June 2010 failed to reach a political agreement on a global bank tax, as sev-eral countries, headed by Canada (which has not had to spend any public funds on bank bailouts), refused to countenance any additional taxation of their banks. The strongest advocates in favour of such taxation were the United States, the United Kingdom, Germany and France. The European

Council, at its meeting on 17 June 2010, agreed that “Member States should introduce systems of levies and taxes on financial institutions to en-sure fair burden-sharing”.37 These levies and taxes should be part of a resolution framework for deal-ing with bank failures. Under European Commis-sion plans, a legislative proposal for a comprehen-sive EU framework for crisis management in the financial sector is due to be presented in summer2011. At the same time, however, ten EU countries have unilaterally decided to introduce their own systems for the additional taxation of banks (see Table 9). Some countries have introduced taxes on bonuses paid to bank employees.38 The draw-back of such an uncoordinated approach is that the impact differs in different parts of the EU. Themain problem may be the prevention of double taxation of bank balance sheets, the result being that certain cross-border banks could face a con-siderable (up to 25%) drop in profits.39

The IMF, in its recommendations to the G-20 re-garding the best way to impose additional taxes on banks, suggests two categories of tax (levy):40

37 http://www.consilium.europa.eu/uedocs/cms_data/docs/press-data/SK/ec/115368.pdf

38 In 2009, a temporary tax on bonuses was adopted in the UK (on banks and building societies) and in France (on credit institutions and investment firms other than assetmanagement companies). In Italy, a permanent tax on bonuses and stock options paid to managerial employees and to independent financial professionals entered intoforce on 1 January 2010.

39 Jenkins, P. and Wiesmann, G., “New taxes slash European bank profits.www.ft.com ”, 9 January 2011.

40 IMF, “A fair and substantial contribution by the financial sector– final report for the G-20”, June2010.

http://www.ft.com

http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/SK/ec/115368.pdf



http://www.ft.com

57NBS


A N N E X 1

1. a financial stability contribution (a correctivetax),

2. a financial activities tax.

FINANCIAL STABILITY CONTRIBUTION

A financial stability contribution (FSC) – a cor-rective tax on financial institutions – could inconjunction with macro-prudential regulation restrict the negative externalities arising from private decisions in the financial sector.

Ex ante taxation may be perceived by the finan-cial sector as an explicit insurance against failure such that supports moral hazard (where activi-ties of financial institutions are risky to the pointof being socially undesirable). What matters here is the possibility of failure of a bank, even a systemically important financial institution(SIFI). Market discipline can be enforced and ex-cessive risk-taking discouraged only if the cost of any failure will be fully borne by the sharehold-ers and unsecured creditors – without involving the taxpayer. A special resolution regime for any failure of SIFIs must be in place, in order to avoid a financial panic and a domino effect of failuresin the financial sector.41 Bank taxes collected ex ante should therefore be linked to a special reso-lution mechanism and their collection should be the responsibility of a resolution agency under which the mechanism will be operated.

If the taxes were imposed only on banks, the system risk would move to other segments of the financial sector. Therefore, all financial insti-tutions should be subject to an FSC, with their significance in systemic risk terms taken intoaccount in the tax base (e.g. a lower base for in-surers than for banks) and in the tax rate (a sub-stantially lower rate for small, conservative banks than for large, complex banks). After the system has been launched, it could be gradually refinedto the point where each institution is subject to a particular rate that reflects its individual riskprofile, and/or its contribution to systemic risk.The level of rates could also take into account the current phase of the business cycle, which would have a mitigating effect on its procyclicalbehaviour.

The preferred tax base is the financial liabilitiesof financial institutions, ideally after deductingequity and insured liabilities. There is, for exam-

ple, a proposal to tax banks’ non-core liabilities,42 comprising various types of wholesale funding (including funding in foreign exchange) outside retail deposits. During a credit boom, the aggre-gate share of non-core funds in the banking sec-tor’s total liabilities will have a rising tendency, since the amount of retail funds is insufficientto fund the rapid expansion of lending. Other factors in this regard are the increasing intercon-nectedness of financial institutions (through therise in mutual exposures) and the shortening of maturities on the liability side, as more enti-ties become involved in the intermediation of funding (securitisation). Since the amount of the banking sector’s non-core funds is a sound indicator of the stage of the credit cycle and the extent to which risks are underestimated, the in-troduction of a tax on these funds could restrict externalities related to excessive lending growth and to systemic risk arising from the intercon-nection of banks. The tax base may also include certain off-balance sheet items that are sourcesof systemic risk.

The gross government outlays initially required in the event of a systemic crisis may be far ex-ceeded by the final net outlay. This means thatthe capacity of the resolution fund may also be exceeded. In that case, the IMF recommends that the resolution agency be given access to a gov-ernment credit line as well. Since such credit lines represent a permanent claim on govern-ment funds, financial institutions should haveto pay the government a special charge for the privilege (far lower than the tax). The govern-ment may decide to continue levying the tax on financial institutions even after acquiring the tar-get amount of revenue for the resolution fund. The tax receipts could then be redirected to the state budget, while the corrective effects of tax-es on the behaviour of financial institutions aremaintained.

FINANCIAL ACTIVITIES TAX

As we mentioned at the beginning of the paper, the overall costs (fiscal, economic, social) thata country will face as a result of a systemic crisis are many times higher than the direct fiscal costof rescuing financial institutions. The correctivetaxes analysed above are focused only on the marginal social damage of certain financial sec-tor activities. It is legitimate to levy additional

41 Within the scope and subject-mat-ter of this article, it is not possible to discuss which characteristics should be met or how a SIFI resolu-tion regime should be made to operate effectively.

42 Shin, H.S., “Macroprudential poli-cies beyond Basel III,” Policy memo, Princeton University, 22 November 2010.

58NBS


A N N E X 1

taxes on financial institutions, provided thatthese taxes are directed at the average social damage and their principal objective is to raise fiscal revenue; otherwise, the damage wouldhave to be compensated out of a rise in general taxation and public spending cuts. The IMF, in its recommendations to the G-20, proposes the introduction of a financial activities tax (FAT),levied on the sum of profits and remuneration offinancial institutions. This is analogous to value-added tax (VAT), since an income equivalent of overall value added is the sum of wages and prof-its with the latter defined in terms of “cash flow”.A FAT in effect taxes net transactions of financialinstitutions. At the same time, the IMF does not recommend the imposition of taxes on gross financial transactions – i.e. the various forms offinancial transactions tax (FTT), such as a “Tobintax” on foreign exchange transactions.43

A FAT offers the state another benefit, apartfrom substantial additional revenue potential. If the base is correctly set – to include only profitsabove a “normal” level and “high” remuneration – a FAT will serve as a tax on excessive profits inthe financial sector, i.e. it will be a type of taxon rents in the financial sector (income that ispurely related to the specific nature of the busi-ness and the position of the financial sectorin the economy). As a tax on excessive profits,a FAT could help reduce excessive risk-taking by financial institutions, where managers or deal-ers at financial institutions underestimate risksdue to the expectation that any losses will ul-timately be borne elsewhere (by the state/tax-payers).

With the inclusion of all remuneration in the tax base, a FAT would effectively be a tax on valueadded in the financial sector. Such a tax wouldoffset the favourable treatment that the financialsector receives under existing VAT in comparison with other sectors. For technical reasons, finan-cial services are VAT-exempt in certain countries; consequently, the financial sector may be “toobig” vis-à-vis the rest of the economy. The rate of this tax should not be too high, so as to avoid any undesirable effect (the transfer of profits andwages to countries with a lower tax burden). Even a FAT that is levied at a rate well below the VAT rate could bring in significant revenue (de-pending on the size of the financial sector in thegiven country).44

Another advantage of a FAT, according to the IMF, is that it would be relatively straightfor-ward to implement, since it would draw on the practices of established taxes. Like VAT, it would not directly affect the structure of the activitiesundertaken by financial institutions. But unlikeVAT, a FAT would also fall on businesses (finan-cial corporations), not just on final consum-ers. The incidence of, and revenue from, a FAT would depend on the precise definition of thebase. The closer the tax is to falling on rents in the financial sector (profits above a “normal”level and “high” remuneration), the less is the incentive for it to be passed on to customers of financial institutions – through higher charg-es and interest rate margins – rather than be borne by owners and managers. In order to tax the rents included in profits, it would be neces-sary to define profits in terms of cash flow, i.e.similar to the definition implicit in VAT (invest-ments are fully deductible; interest expenses are not deductible).45 Rents, as a part of profits,which should be the (main) target of taxation, would then equal the return to equity above a selected reference rate. The reference level for setting the rent components of remuneration, as with profits, is determined by an expert es-timation. Thus, in both cases there is a risk that the tax falls on profit/income which is high asa result of strong productivity and not of exces-sive risk-taking.

CONDITIONS FOR THE EFFECTIVE ADDITIONAL TAXATION OF FINANCIAL INSTITUTIONS

History indicates that no country is completely immune from the risk of financial crisis and thatfinancial crisis entails high costs. That is why itmakes sense to look at effective ways of meet-ing the cost of future crises. One solution would appear to be some form of additional taxation of banks. In order to maximise the effect of impos-ing a corrective tax on financial institutions andtaxes on financial activities, several conditionswill have to be satisfied:46

1. The global nature of financial markets meansthat there must be international coordina-tion not only in financial regulation, but alsoin the additional taxation of banks. An inter-national agreement, at least on basic princi-ples for the taxation of financial institutions,will help reduce the incentive to avoid tax through the relocation and restructuring of

43 An FTT does not have corrective po-tential in relation to systemic risk; its impact would be substantial on customers, but minimal on the managers and owners of financialinstitutions. There are already far more efficient means for the stateto generate revenue. For a more detailed discussion on FTTs, see Matheson, T., “Taxing Financial Transactions: Issues and Evidence”, Financial sector taxation: The IMF’s report to the G-20, September 2010.

44 For further details, see the IMF publication “A fair and substantial contribution by the financial sector– final report for the G-20”, Appen-dix 6, Part B, June 2010.

45 A basic feature of this type of taxation is its neutrality in regard to investment decisions. Further information on the technical de-tails of how to define profit for FATpurposes can be found in Keen, M., Krelove, R., Norregaard, J., “The Fi-nancial Activities Tax”, in “Financial sector taxation: The IMF’s report to the G-20”, September 2010.

46 IMF, “A fair and substantial contribution by the financial sector– final report for the G-20”, June2010.

59NBS


A N N E X 1

Box 2

financial activities.47 International coordina-tion is important not only for the mitigation of competitive distortions, but also for the prevention of double taxation (through a tax agreement);

2. In the context of the additional taxation of financial institutions, it is very important tostep up efforts against their aggressive taxplanning;

3. Actions will be needed to reduce current tax distortions, such as the deductibility of inter-est expenses. These represent a tax bias that favours debt financing (leverage) at the ex-pense of equity financing.

4. When implementing and designing new taxes/levies on financial institutions, it will benecessary to take into account the expected costs of future regulatory policies, in order to avoid excessive taxation of financial institu-tions.

WHICH APPROACH/PROCEDURE TO CHOOSE FOR SLOVAKIA?

From the above, it may be concluded that while conditions in Slovakia are politically very con-ducive to the imposition of additional taxes on financial institutions (banks) – given the weak-ened state of public finances (see Box) – thetechnically preferable approach should be to in-crease the focus on financial stability. Since thegeneral government budget deficit and publicdebt in Slovakia have been rising (particularly in the last two years) due to a combination of the adverse repercussions of the global economic crisis and an excessive increase in government expenditure (mainly in 2009), the grounds for ex post taxation of financial institutions are lessstrong here than they are in those countries that spent large amounts of public funds on the di-rect rescue of financial institutions and on thestabilization of their financial systems.

SPECIAL BANK LEVY PLANNED IN SLOVAKIA48

A levy on banks and branches of foreign banks in Slovakia is laid down in a draft law concern-ing a special levy on selected financial institu-tions and amending Act No 479/2009 Coll. on state administration authorities in taxes and fees (hereinafter referred to as the Act). The base of the levy is defined in the draft law as

the sum of liabilities less the sum of equity and the value of protected deposits. The proposed rate of the annual levy is 0.2% of this base. The levies should constitute revenue of the state budget, and they should be administered by Tax Authority. The law is due to enter into force on 1 January 2012.

At the technical level, a more pertinent issue is how to meet the costs of future financial crises.Banking in Slovakia has a conservative model, but even here there are elements of systemic risk. It is therefore justified to impose at leasta minimum additional tax on the banks, in order to create within a specified time period a specialresolution fund for dealing with any future finan-cial (banking) crisis.49 Such a fund would be part of the resolution mechanism in the financial sec-tor, which would in no event be used to rescue banks, whether systemically important or not (on the contrary, its main role would be to support the controlled failure of a financial institution). Inview of the undesirable effects, it would be coun-terproductive if Slovakia unilaterally decided to impose a tax on financial institutions in order to

support financial stability. The European Com-mission’s draft law on a new crisis management framework for the EU financial sector is due to bepresented in summer 2011.50 This framework will apply to banks and investment firms and it willalso require Member States to establish bank res-olution funds.51 These funds should be financedout of contributions from banks and investment firms, with the contribution of each firm set ac-cording to the size of their liabilities. During the approval process for this legislation, Slovakia should push for an agreement on common prin-ciples in the taxation of financial institution’s li-abilities – i.e. an EU-level agreement on the tax base and minimum rate – one in which the Mem-ber States have some discretion in adjusting the taxation parameters to their local conditions (the

47 For example, the common adop-tion of minimum tax rates can help to substantially limit collective losses from non-cooperative tax-setting.

48 https://lt.justice.gov.sk/Material/MaterialDocuments.aspx?instEID=-1&matEID=3973&langEID=1

49 A decision on the taxation of other financial institutions, for example,insurers should take into account their contribution to systemic risk. In Slovakia, this contribution is at present negligible.

50 http://ec.europa.eu/internal_mar-ket/consultations/docs/2011/crisis_management/consulta-tion_paper_en.pdf

51 Before the end of 2011, the EC will put forward a proposal for similar measures in relation to other types of financial institution, includinginsurance companies.

https://lt.justice.gov.sk/Material/MaterialDocuments.aspx?instEID=-1&matEID=3973&langEID=1



http://ec.europa.eu/internal_market/consultations/docs/2011/crisis_management/consultation_paper_en.pdf

60NBS


A N N E X 1

extent to which financial institutions contributeto systemic risk).52 The main consideration when setting the tax base should be the corrective ef-fects of the tax.

In October 2010, the European Commission ex-pressed support for the introduction of a FAT (as a bank tax on profits and wages) at the EUlevel.53 Another EC initiative in this regard was a public consultation that closed in April 2011.54 On one hand, the introduction of a FAT across the EU would temper the edge that the finan-cial sector has been given over other sectors of the economy by virtue of its position under the VAT regime; on the other hand, the imposition of a FAT on banks would very likely lead to a further increase in customer fees and to a rise in interest margins, which are already high. Banks also ar-gue that since their reporting is not based on the recording of cash flows, the introduction of thetax in its planned form would place a heavy ad-ministrative and financial burden on them.55 The reason for imposing this tax should be to refund the public funds or other indirect costs spent or incurred on measures to resolve the crisis in the financial sector.To levy this tax at the national lev-el, however, except as a short-term policy, would in the context of the EU Single Market involve the risk of undesirable effects in the banking sec-tor and economy. Further drawbacks of such an ex post tax are that it would affect only the sur-

viving firms (not those that went bankrupt) andwould have a procyclical effect (increasing costat the worst possible time).

References

Alessandri, P., Haldane, A.G., “Banking on the state”, Bank of England, November 2009.

European Banking Federation, EBF comments on the European Com-mission’s consultation paper on financial sector taxation, April 2011, available at www.ebf-fbe.eu

Financial Stability Board, Progress in the Implementation of the G20 Recommendations for Strengthening Financial Stability, February 2011, available at http://www.financialstabilityboard.org/publica-tions/r_110219.pdf

FT Reporters, “European states braced for tax backlash”, Financial Tines, 11 January 2011, available at www.ft.com

Keen, M., Krelove, R., Norregaard, J., “The Financial Activities Tax”, Financial Sector Taxation: The IMF’s Report to the G-20 and Background Material, September 2010.

Laznia, M., “Systém krízového riadenie bánk: nástrahy návrhu”, Biatec, April 2011.

Matheson, T., “Taxing Financial Transactions: Issues and Evidence”, Financial Sector Taxation: The IMF’s Report to the G-20 and Background Material, September 2010.

IMF, A fair and substantial contribution by the financial sector – finalreport for the G-20, June 2010.

Schildbach, J., “Direct fiscal cost of the financial crisis”, Deutsche Bank Research, 14 May 2010.

Shin, H.S., “Macroprudential Policies Beyond Basel III”, Policy Memo, Princeton University, 22 November 2010.

52 Minimum common principles should also be agreed for any additional taxation and fees, where the resolution fund is found to be insufficient to deal with a crisis andthe government or central bank needs to borrow funds for this purpose.

53 http://ec.europa.eu/taxation_cus-toms/resources/documents/taxa-tion/com_2010_0549_en.pdf

54 http://ec.europa.eu/taxation_cus-toms/resources/documents/common/consultations/tax/fi-nancial_sector/consultation_docu-ment_en.pdf

55 EBF comments on the European Commission’s consultation paper on financial sector taxation, April 2011,available at www.ebf-fbe.eu

http://www.ebf-fbe.eu



http://www.ft.com

http://ec.europa.eu/taxation_customs/resources/documents/taxation/com_2010_0549_en.pdf



http://ec.europa.eu/taxation_customs/resources/documents/common/consultations/tax/financial_sector/consultation_document_en.pdf





http://www.ebf-fbe.eu

61NBS


A N N E X 2

2 THE EFFECT OF THE FINANCIAL CRISIS ON PUBLIC FINANCE POSITIONS

ANNA STRACHOTOVÁ

In this paper, we examine the identification ofthe channels through which the financial andeconomic crisis has affected the debt position ofthe public sector in Slovakia and in selected EU countries. In particular, we analyse how changes in the growth rate of the economy, inflation, andfiscal deficit are affecting the sustainability of thedebt position and sensitivity to movements in these parameters.

The financial and economic crisis has causeda sharp rise in the fiscal deficits and public debtsof EU countries. In advanced economies, mount-ing indebtedness has resulted in governments providing substantial support for aggregate de-mand and key sectors (stimulus measures) and assuming liabilities from financial and non-finan-cial corporations. In new EU countries, the rise in public debt had more to do with a drop in rev-enues caused by the decline economic activity.

Besides steeply rising debt, certain EU countries have in the last two years seen an unprecedent-ed rise in the risk premium on their long-term sovereign debt. With financial markets lackingconfidence in several EU Member States, the EUand international organisations1 faced the neces-sity of supporting these countries. Thus, the debt crisis in euro area peripheral countries emerged during the course of 2010.

Sovereign debts are expected to rise still further in the years ahead, before the countries would be able to meet their fiscal consolidation targets.Given the negative effects of high indebtednesson potential growth and on monetary and finan-cial stability, fiscal policy must pursue a strategythat, firstly, stabilises the debt ratio at the currentlevel and then, secondly, normalises the fiscaland balance-sheet position of the general gov-ernment sector in the medium-term horizon. For a number of countries, this will entail consolida-tion measures that go some way further than simply restoring the pre-crisis situation. Coun-tries need to reckon not only on the most prob-

able scenario, but also on risks associated with shifts in the parameters that affect governmentdebt dynamics.

The medium and long-term sustainability of gov-ernment debt positions is an issue made more urgent by Europe’s ageing populations, which will in future add considerable costs to public fi-nance balance sheets.

The recent difficulties have led to questionsabout the adequacy and sustainability of public sector debt, which could have a strongly adverse effect on growth outlooks in EU countries and onprivate sector financing. The escalation of sover-eign debt crises and the possibility of contagion mean heightened risks also for financial institu-tions exposed to sovereign debts, as well as for other countries that have so far been reporting a basically sound debt position but weaker mac-roeconomic fundamentals.

SIGNIFICANCE OF THE GOVERNMENT SECTOR FOR FINANCIAL STABILITY

The public sector debt position is an important aspect of macroeconomic fundamentals and fi-nancial policy. Since public finances are able togenerate stable revenue streams in the future, government securities carry a low risk of default or extension and they are highly liquid. Govern-ment securities therefore have the right proper-ties to serve financial markets as a benchmark formeasuring the risk level of other financial assets ina given economy.

The indebtedness of the general government sector stems mainly from fiscal policy decisions,but also from the monetary-policy framework. Imbalances in private sector balance sheets (im-plicit liabilities and guarantees to financial andnon-financial corporations) may spill over to thepublic sector balance sheet, as may the effectsof interactions between the financial balancesheets of economic sectors (Allen, 2002).

56 Hungary and Latvia adopted IMF programmes under which they im-plemented stabilisation measures, including the tightening of fiscalpolicy in 2008; Greece received financial assistance from the EU inMay 2010, followed by Ireland in November 2010, and Portugal in May 2011.

62NBS


A N N E X 2

Box 3

The relationship between public finances and fi-nancial stability is affected by the nature of fiscalpolicy (the level of revenues), the debt stock, the debt profile (type of debt instruments and theirmaturity), the investor base, the stage of devel-opment of the capital market, and institutional factors (Das, 2010). In this paper, we focus only on risks arising from the overall debt stock.57

FISCAL SUSTAINABILITY

Retaining confidence in fiscal solvency is crucial.According to economic theory, fiscal solvencymeans that the government is able to gener-ate primary balance surpluses in the future in order to cover debt servicing payments (i.e. the present, discounted value of future primary sur-pluses must equal the value of the current public debt). The theoretical concept of sustainability is flawed in that it is too general and cannot be ap-plied in decisions on the nature of fiscal policy,

since it states only that the debt must be repaid at some point in the future.

In practice, the most frequently used benchmark for distinguishing sustainable fiscal policies fromunsustainable ones is non-increasing government debt (usually as the ratio of gross government debt-to-GDP). Fiscal sustainability in the most nar-row sense means achieving a fiscal balance thatstabilises the public finance deficit and govern-ment debt at a certain specified level. Under thewidely known Maastricht criteria, which are bind-ing on EU countries, government debt should not exceed 60% of GDP, or should converge to this limit if it is at a higher level. Recent developments indicate, however, that a simple numeric target is insufficient and that when assessing the sustain-ability of debt, it would be more appropriate to take into account the particular circumstances of a specific country (e.g. the level and volatility of itsbudget revenues, the debt structure, etc.).

MATHEMATICAL APPARATUS FOR THE CALCULATION OF GOVERNMENT DEBT DYNAMICS

The accounting identity of the budget of the consolidated government sector can most generally be expressed as:

� � � �HHDDTDiG tttttttt 111 ��

pbdyyi

dd tt

t

ttttt ��

�� 111

pbdggr

dd tt

t

ttttt ��

�� 111

ggr

dpb

t

t

��

�� 11

)(1 0

** ddpb NN

Nt ��

��

� ��

g

gr

��

��

sfapbdyyi

dd ttt

t

ttttt ��

�� 111

pbdggrdd tt

t

tttt ��

�� 111

(b1)

where:G is the government’s nominal primary ex-penditure; i is the nominal implicit interest rate of the debt D. The implicit interest rate is calculated as the ratio of paid interest expenses to the debt as at the end of the previous year;T is the government’s budget revenues;D

t - D

t-1 is the issuance of new debt;

Ht - H

t-1 is seignorage, the change in the stock of

the central bank’s liabilities or monetary base. We assume that the long-term inflation rate islow and stable, so that this source of public fi-nances generates low revenues, and we then abstract from it.

The equation (b1) implies that government expenditure G and debt servicing costs accu-

mulated in the previous period Dt-1

must be lower or equal to the sum of tax revenues T, is-suance of new debt D

t –D

t-1 and revenues from

seignorage Ht –H

t-1.

The change in public debt is expressed in terms of ratios to nominal GDP:

Box 1 Matematický aparát pre výpo�et dynamiky dlhu

Po vyjadrení v podieloch nominálneho HDP je zmena verejného dlhu:

pbdyyidd tt

t

tttt

��

��

�� 11 1 (b2)

kde y je rast nominálneho HDP a pb je primárna bilancia rozpo�tu, alebo

pbdggrdd tt

t

tttt �

�

��

�� 11 1 (b3)

kde r je reálna implicitná úroková sadzba a g je rast reálneho HDP

sfapbdyyidd ttt

t

tttt ��

�

��

�� 11 1 (b6)

kde sfa je zosúladenie dlhu a deficitu

(b2)

where y is nominal GDP growth and pb is the primary budget balance, or



pbdyyidd tt

t

tttt

��

��

�� 11 1 (b2)


pbdggrdd tt

t

tttt �

�

��

�� 11 1 (b3)


sfapbdyyidd ttt

t

tttt ��

�

��

�� 11 1 (b6)


(b3)

where r is the real implicit interest rate and g is real GDP growth.

Government policy affects the level of debtthrough the primary balance pb and real inter-est rate r. If real interest rates are higher than the real growth of the economy, the debt ra-tio may rise even if the government achieves a primary surplus.

57 The different features of the debtstructures of 23 EU countries are presented in a study by Eminescu (2010).

63NBS


A N N E X 2

A basic condition of debt sustainability is con-vergence of the debt to a specific final limit.The increase in the debt ratio must be lower than the rise in interest rates (the so-called no-Ponzi game condition). In the case of a Ponzi financial scheme, the current debt is serviced(for infinite time horizon) by the issuance ofadditional debt, which covers the debt inter-est and principal payments. Assuming that creditors behave rationally, financing on thebasis of a such a Ponzi scheme would not work (Chalk, 2000).

CONDITION FOR MAINTAINING A CONSTANT DEBT RATIO

Where the debt ratio in relationship (3) does not change, d

t – d

t-1 = 0, then


pbdyyi

dd tt

t

ttttt ��

�� 111

pbdggr

dd tt

t

ttttt ��

�� 111

ggr

dpb

t

t

��

�� 11

)(1 0

** ddpb NN

Nt ��

��

� ��

g

gr

��

��

sfapbdyyi

dd ttt

t

ttttt ��

�� 111

pbdggrdd tt

t

tttt ��

�� 111

(b4)

The primary surplus-to-debt ratio must match the difference between the real yield on thedebt and the real output growth. This relation-ship may be depicted graphically by a straight line intersecting the x-axis at an angle of 45 degrees.

THE PRIMARY BALANCE THAT ALLOWS THE GIVEN DEBT RATIO TO BE ATTAINED WITHIN A FINITE TIME HORIZON

If a constant primary balance pb* is maintained, the target debt ratio can be attained where:


pbdyyi

dd tt

t

ttttt ��

�� 111

pbdggr

dd tt

t

ttttt ��

�� 111

ggr

dpb

t

t

��

�� 11

)(1 0

** ddpb NN

Nt ��

��

� ��

g

gr

��

��

sfapbdyyi

dd ttt

t

ttttt ��

�� 111

pbdggrdd tt

t

tttt ��

�� 111

(b5)

where d0 is the initial debt ratio, and

d*N

is the planned debt ratio that should be attained within N time periods


pbdyyi

dd tt

t

ttttt ��

�� 111

pbdggr

dd tt

t

ttttt ��

�� 111

ggr

dpb

t

t

��

�� 11

)(1 0

** ddpb NN

Nt ��

��

� ��

g

gr

��

��

sfapbdyyi

dd ttt

t

ttttt ��

�� 111

pbdggrdd tt

t

tttt ��

�� 111

DECOMPOSING THE INCREASE IN THE DEBT RATIO, INCLUDING A STOCK-FLOW ADJUSTMENT

If we assume that the debt is also affected byfinancial operations, such as privatisation reve-nue or the effect of exchange rate movementson debt issued in foreign currency, equation (b2) will be expanded to include a stock-flowadjustment



pbdyyidd tt

t

tttt

��

��

�� 11 1 (b2)


pbdggrdd tt

t

tttt �

�

��

�� 11 1 (b3)


sfapbdyyidd ttt

t

tttt ��

�

��

�� 11 1 (b6)


(b6)

where sfa is a stock-flow adjustment.

THE ROLE OF INTEREST RATES, INFLATION AND ECONOMIC GROWTH IN DEBT DYNAMICS

The development of the debt ratio d is character-ised by the equation58


pbdyyi

dd tt

t

ttttt ��

�� 111

pbdggr

dd tt

t

ttttt ��

�� 111

ggr

dpb

t

t

��

�� 11

)(1 0

** ddpb NN

Nt ��

��

� ��

g

gr

��

��

sfapbdyyi

dd ttt

t

ttttt ��

�� 111

pbdggrdd tt

t

tttt ��

�� 111 (1)

where d is the debt ratio, r are real implicit inter-est payments (adjusted for real economic growth g), and pb is the primary balance.

The change in the debt ratio is influenced by debtservicing costs from the past and by the primary balance of the general government budget. Equa-tion (1) shows that the size of the debt affects theextent to which real GDP growth reduces the debt dynamics. A change in the differential betweeninterest rates and growth (where real growth is g and real interest rates are r) means that, in re-lation to the debt ratio, fiscal consolidation must

be more intensive (the primary surplus necessary for stabilisation must be higher). Countries with a high debt burden are more sensitive to a decline in growth, but also to a fall in the inflation rate.

The difference between real interest payments andreal GDP growth – the differential (r

- g)59 – is a basic

parameter that determines the development of the debt ratio. For advanced market economies, the dif-ferential (r

- g) is positive over a long time period,

since real interest rates are higher than real growth. A negative differential is treated as a temporaryphenomenon60 that occurs mainly in emerging economies, where economic growth is rapid and the inflation rate, as measured by the GDP deflator,which has been the case in the new EU countries. This was even the case in the euro area periphery economies in the period following their entry into the bloc, when interest rates fell sharply.

Economies with a negative differential can reporta primary deficit (up to a certain level) and at the

58 The mathematical apparatus for the calculation of government debt dynamics is presented in Box 3.

59 For simplicity, we refer to the entire equation (r

t - g

t)/(1+ g

t ) as (r - g) in

the rest of the paper. 60 Escolano, 2010.

64NBS


A N N E X 2

Table 10 Debt consolidation (% GDP)

Debt ratio Primary balance

2002 Change2002-2007

Change 2008-2010

Change 2010-20121)

2010 Structural PB2)

Czech Rep. 28.2 0.8 8.6 4.4 -3.3 -2.6Estonia 5.7 -2.0 2.0 0.4 0.3 2.6Ireland 32.1 -7.1 51.8 21.7 -29.2 -27.0Greece 101.7 3.8 32.0 23.4 -4.9 -2.7Latvia 13.5 -4.5 25.1 4.7 -6.2 -3.6Lithuania 22.3 -5.4 22.6 5.4 -5.3 -3.3Hungary 55.6 10.5 7.9 -7.5 -0.1 2.0Poland 42.2 2.8 7.9 0.1 -5.2 -4.7Portugal 53.7 14.4 21.4 14.4 -6.1 -5.8Slovenia 28.0 -4.8 16.1 8.0 -4.0 -1.4Slovakia 43.4 -13.8 13.2 5.8 -6.6 -6.1Source: EC, May 2011. 1) EC forecast.Note: Structural payment balance – primary balance adjusted for cyclical effects.

Chart 73 Gross debt (% of GDP)

Source: EC. 1)EC projections.

201020092002-2007 20121)

GR

IE

PT

HU

PL

LV

SK

SI

CZ

LT

EE

0 20 40 60 80 100 120 140 160 180

same time maintain an unchanged debt ratio. Where a negative differential (r

- g) is maintained

over a long period, there is a certain maximum primary deficit consistent with a non-increasingdebt burden.61

DEBT POSITION OF THE PUBLIC SECTOR

We will compare the developments in public sector debt position in one group of countries comprising Slovakia and five other euro areacountries (Greece, Ireland, Portugal, Slovenia, and Estonia) and a group of new EU Member States comprising the Czech Republic, Hungary, Poland, Lithuania and Latvia.

In terms of their general government balances, these countries are relatively heterogeneous. Greece, Hungary, Portugal and Poland have long been accumulating high debts, while other countries recorded rising debt as a repercussion of the financial crisis (Ireland) and after the crisisspilled over to the real economy. Before the crisis, all the countries apart from Greece had a debt ra-tio that complied with the Maastricht criteria.

The very low levels of government debt reported by the Baltic States were to a large extent the re-sult of the fixed exchange rate regime used bythese countries. Nevertheless, domestic econom-ic conditions led to a sharp rise in the external debt of the private sector. The steps taken to solve the imbalances that emerged after 2007 have had a strong upward effect on public sector debt.

During the period from 2002 to 2008, a wors-ening of the debt ratio was recorded by all the countries under review except for those that joined the euro area62 (Slovenia, Slovakia, and Estonia) and Lithuania. The European Commis-sion assumes a further deterioration in the debt ratio of all the countries (except Hungary) both at present and in the horizon up to 2012.

Chart 73 shows the differences between thedebt ratio in the pre-crisis period and its subse-quent rise.

61 According to the equation (b4) in Box 3.

62 Slovenia joined the euro area in 2007, Slovakia in 2009, and Estonia in 2011.

65NBS


A N N E X 2

Chart 74 Net debts and fiscal balances (% of GDP)

Source: EC, Eurostat, NBS calculations.Note: Average for 2002-2007 in comparison with the situation in 2009.

Chart 75 Real GDP (annual percentage changes)

Source: EC May 2011. 1) EC projection.

40

20

0

-20

-40

-60

-80

-100

EELTCZ

SISKLV

-18 -9 0

PLHUPT

IEGR

structural fiscal balance

net d

ebt

-12 -3-15 -6 3

12

8

4

0

-4

-8

-12

EEIEGR

PTSISK

20021998 2000 2004 2006 2008 20121)2010

12

8

4

0

-4

-8

-12

-16

CZLVLT

HUPL

20021998 2000 2004 2006 2008 20121)2010

The public sector debt position may also be as-sessed on the basis of net debt development. Net debt (liabilities less financial assets) indi-cates the extent in which sector’s liabilities are covered by financial assets that could potentially(relatively quickly) be used for debt repayment. The net debt position is usually referred to less

often, given the higher volatility of its develop-ment and lower transparency.63

The fiscal position in Chart 74 (adjusted for one-off and cyclical effects) provides additional infor-mation about the extent to which the countries have increased their debt through additional fiscalflows. Under the revised Growth and Stability Pact,countries are required as a medium-term objec-tive to achieve a structural deficit not exceeding1% of GDP. Except for Estonia and Ireland, none of the countries under review met this requirement prior to the crisis, and, at present, this group of countries are further away from this benchmark than they were then, except for Hungary.

Of the five countries that had a net creditor po-sition before the crises, only Estonia64 has main-tained it. Estonia was also reporting a fiscal sur-plus before the crisis, as was Ireland, and so these countries were not accumulating debt through additional fiscal flows. The largest relative indebt-edness – as well as largest gross and net debts – were recorded by Greece, Portugal and Hungary.

GDP DEVELOPMENTS

In the pre-crisis period, the countries were record-ing robust growth that helped to mitigate the debt dynamics. In the new EU Member States, this development was driven by an extensive inflow of

63 The gross debt data are immedi-ately accessible and accurate, while the evaluation of the amount and liquidity of financial assets is moreproblematical.

64 The accumulation of considerable fiscal reserves in the pre-crisis pe-riod meant that Estonia was able to meet the Maastricht criteria despite its GDP contracting in the 2008 and 2009.

66NBS


A N N E X 2

Chart 76 Real implicit interest rates (% )

Source: EC May 2011, NBS calculations. 1) EC projection.

12

8

4

0

-4

-8

-12

EEIEGR

PTSISK

20022000 2004 2006 2008 20121)2010

12

8

4

0

-4

-8

-12

CZLVLT

HUPL

20022000 2004 2006

-16

2008 20121)2010

capital from abroad and favourable conditions for financing. By the end of 2008, the countries hadremained unscathed by the financial crisis. Marketconfidence in emerging economies dissipated af-ter September 2008 and countries were hit hard by the crisis through financial channels/markets.65 Two countries that largely escaped this pressure were Slovenia, already by then a member of the euro area, and Slovakia, with the conversion rate of its currency vis-à-vis the euro having already been set and the country confirmed as being oncourse to join the euro area. In 2009, however, the troubles in financial markets spilled over to thereal economy and resulted in a recession (in all the countries except for Poland).

In 2010, a majority of the countries saw a return to growth. The EC does not, however, expect growth to return to pre-crisis levels before 2012.

INTEREST RATE DEVELOPMENTS

Charts 76 show the development of implicit in-terest rates over the last ten years. These rates are formed by the sum of interest expenses paid in the given year relative to the overall debt in the previous year. The level of interest expenses is determined by decisions taken in the past and is dependent on the composition and maturity of the debt. After deducting the rate of inflation

in the economy, as measured by the GDP defla-tor, we obtain information about the real interest rates.

In the period 2000–2007, the conditions for debt consolidation were favourable also because real interest rates were low and falling. It was general-ly the case before the crisis that real interest rates were low, liquidity in the markets was sufficient,and risk premia were modest. In addition, new EU Member States were viewed very positively in comparison with other emerging economies, as their risk premia were relatively low (Lueng-naruemitchai, 2007).

Following a change in the parameters (slump in GDP, decline in inflation), the rates climbed sharply.The rise in interest rates was probably affected alsoby risk factors such as the development of expect-ed inflation, the deterioration of the fiscal position,and the expected exchange rate movement.66

The overall effect of the crisis on the differential(r-g) and expected development up to 2012 is shown in Chart 77.

PUBLIC FINANCE DEVELOPMENTS

The EC uses the cyclically-adjusted primary bal-ance as the main indicator of a country’s fiscal

65 For further analysis of how the financial and economic crisis af-fected new EU Member States, see, for example, Gardo (2010), Lewis (2010).

66 The literature on the determinants of interest rates on government securities issued by new EU Member States does not as yet offerany clear conclusions. It is stated that variables explaining spread movements in the case of ad-vanced market economies function substantially less well in the case of new Member States.

67NBS


A N N E X 2

Chart 77 Differential (r-g) (% )


Chart 78 Primary balance (% of GDP)

Source: EC May 2011, NBS calculations.

16

12

8

4

0

-4

-8

-12

-16

EEIEGR

PTSISK

20022000 2004 2006 2008 20121)

19,5

2010

25

20

15

10

5

0

-5

-10

-15

-20

-25

-30

CZLVLT

HUPL

20022000 2004 2006 2008 20121)2010

3

2

1

0

-1

-2

-3

-4

-5

-6

-7

2002-2008 Structural primary balance2002-2008 Primary balance2010 Structural primary balance2010 Primary balance

EE(-27.0)(-29.2)

IE GR PT SI SK

2

1

0

-1

-2

-3

-4

-5

-6

-7

2002-2008 Structural primary balance2002-2008 Primary balance2010 Structural primary balance2010 Primary balance

CZ LV LT HU PL

position. The cyclically-adjusted budget bal-ance measures what the fiscal budget balancewould be if there were no cyclical fluctuationsand if the economy was at its potential/trend level.

The economic crisis depressed potential output. Some of the losses may be permanent, which would mean the loss of certain revenues (related

to, for example, the property boom). A further result of the decline in potential output is a de-terioration in the general government structural deficit, which was even worse during the boomthan had been expected.

The fiscal balance deteriorated during the crisis,from a position that was (on average) relatively weak even during the boom.

68NBS


A N N E X 2

Chart 79 Differential (r-g) and primarybalance – average for 2002-2008


Chart 80 Differential (r-g) and primarybalance – 2009 and 20121)


Table 11 Debt-stabilising primary balance in 2010

Real implicit interest rate (r)

Real growth (g)

(r – g)Debt ratio

Primary balance

Debt-stabilising primary balance

Czech Rep. 5.2 2.3 2.9 38.5 -3.3 1.1Estonia 0.8 3.1 -2.3 6.6 0.3 -0.1Ireland 7.4 -1.0 8.4 96.2 -29.2 8.2Greece 1.8 -4.5 6.2 142.8 -4.9 9.3Latvia 6.3 -0.3 6.7 44.7 -6.2 3.0Lithuania 4.2 1.3 2.9 38.2 -5.3 1.1Hungary 2.5 1.2 1.3 80.2 -0.1 1.0Poland 4.3 3.8 0.5 55.0 -5.2 0.2Portugal 2.7 1.3 1.4 93.0 -6.1 1.3Slovenia 3.9 1.2 2.7 38.0 -4.0 1.0Slovakia 3.5 4.0 -0.6 41.0 -6.6 -0.2Source: EC May 2011, NBS calculations.

5

-5

-15

-25

-35

-45-6

r –g

HUHU

IE

CZ

CZ

SI

SI

PT

PTGR

GR

PL

LVLT

SK

PL

EE

EE

LV

LT

IESK

0 246 1812

pb/d

10

6

2

-2

-6

-10-12 -10 10

r –g

EE (28)

IE

SI

SK

LTHU

CZLV

PT

PL

GR

-8 8-6 6-4 4-2 20

pb/d

INTERACTION BETWEEN THE FISCAL POSITION AND THE ECONOMY’S MACROECONOMIC PARAMETERS

The interaction between the fiscal position andthe differential (r-g) is illustrated in Charts 79and 80. For the debt ratio not to worsen, the primary balance-to-gross debt ratio must be greater than or equal to the differential (r-g).67 This position is indicated by a 45-degree straight line. A country lying on (or above) this line has a stable (or falling) debt ratio.

In the pre-crisis period, most of the observed economies had a primary balance deficit, but the

debt was stabilised by the favourable (i.e. nega-tive) differential (r-g). The overall sound resulttherefore masked the fact that fiscal policy didnot contribute sufficiently to the sustainability ofpublic sector finances and that the debt was sta-bilised mainly by the “automatic” effect of macr-oeconomic parameters.

This problem was revealed after the outbreak of the crisis and the change in parameters. As the crisis mounted (in 2009), fiscal policy positionsshifted to an unsustainable trajectory. Accord-ing to the EC forecast of May 2011, a certain cor-rection is expected to be recorded until 2012,

67 Equation (b4) in Box 3.

69NBS


A N N E X 2

Chart 81 Stock-flow adjustment (% of GDP)

Source: EC May 2011, NBS calculations. 1) EC projection.Note: A positive value indicates a contribution to debt growth.

15

10

5

0

-5

-10

2002-2007 2008 2009-20121)

EE IE GR PT SI SK

15

10

5

0

-5

-10

2002-2007 2008 2009-20121)

CZ LV LT HU PL

given the recovery of economic growth. The main requirement for putting public finances ona sustainable footing is, however, a substantial improvement in the structural primary balance.

DEBT-STABILISING PRIMARY BALANCE

In order to assess the extent to which the cur-rent fiscal position deviates from the sustainablelevel,68 we show in Table 11, in the last column, the benchmark level of the primary balance that the country must attain if it is to maintain its debt ratio at the current level.

In 2010, all the countries (except Estonia) had a primary balance position that was worse than would be necessary to stabilise the debt at the current level. Given the change in the differential(r-g), from negative to positive, stabilisation of the debt ratio cannot be achieved with a primary deficit but requires a primary surplus (except inSlovakia and Estonia).

As the results for new Member States imply, fa-vourable debt dynamics did not help achieve a sufficient consolidation of public finances. Inci-dentally, a situation in which real interest rates in the economy are lower than the rate of econom-ic growth is not standard in advanced countries, indicating as it does the presence of inefficiency

in the economy. An environment of very low (in some countries, even negative) interest rates was driving up borrowing in the private sector, too. In several countries (particularly the Baltic states and Hungary), the situation was made worse by private borrowing in foreign currency.

STOCK-FLOW ADJUSTMENT

In the preceding decomposition of debt dynamics, we assumed that neither the level of the debt in foreign currency, nor value of public sector finan-cial assets undergoes any change and that the debt is pushed up solely by fiscal flows and the effect of macroeconomic parameters. If these effects aretaken into account, however, the debt ratio will also increase through a stock-flow adjustment.

This adjustment takes account of the accumula-tion of financial assets, differences between cashand accrual flows, and the effect of exchangerate movements on the value of the debt de-nominated in foreign currencies, and other sta-tistical adjustments, including the realisation of collateral and assumption of liabilities of the private sector. The effect of the financial and eco-nomic crisis on public finances was also reflectedin the contribution of the stock-flow adjustmentto debt growth (due to, for example, bank rescue operations in several countries in 2008).

68 Equation (b4) in Box 3.

70NBS


A N N E X 2

Table 12 Contributions to the debt ratio change – cumulative for 2002-2008 and 2009-2010 (% of GDP)

Primary deficit1) Snowball effect Stock-flow adjustment

Debt ratio change

Czech Rep. 2002 – 2008 12.3 -4.6 -5.9 1.8

2009 – 2010 7.8 2.9 -2.2 8.5

Estonia 2002 – 2008 -8.3 -2.1 9.3 -1.1

2009 – 2010 1.1 0.8 -0.1 1.8

Ireland 2002 – 2008 -5.9 -2.1 20.3 12.3

2009 – 2010 41.4 13.4 -3 51.8

Greece 2002 – 2008 12.2 -12.5 9.3 9

2009 – 2010 15.2 14.3 2.5 32

Latvia 2002 – 2008 4.7 -8.4 9.8 6.1

2009 – 2010 14.4 8.7 2 25.1

Lithuania 2002 – 2008 2.9 -8.6 -1.1 -6.8

2009 – 2010 13.6 5.5 3.6 22.7

Hungary 2002 – 2008 14.7 -0.8 2.7 16.6

2009 – 2010 0 7.6 0.3 7.9

Poland 2002 – 2008 9.2 -4.6 0.3 4.9

2009 – 2010 9.9 0.3 -2.4 7.8

Portugal 2002 – 2008 6.7 4.1 6.8 17.6

2009 – 2010 13.3 5.4 2.6 21.3

Slovenia 2002 – 2008 0.7 -3.1 -3.4 -5.8

2009 – 2010 8.6 3.4 4 16

Slovakia 2002 – 2008 4.5 -10.6 -9.7 -15.8

2009 – 2010 13.1 3 -2.9 13.2Source: EC May 2011, NBS calculations. 1) Minus sign indicates a surplus.

The decomposition of debt ratio dynamics69 in Table 12 indicates that in the pre-crisis period, all the countries other than Portugal benefitedfrom the positive differential between growthand interest rates. The debt dynamics were af-fected to varying extents by the deficit-debtadjustment. In Ireland, as well as in Latvia, Es-tonia and Greece, the adjustment contributed significantly to the debt growth. Even with de-composition into these factors, consolidating countries (Lithuania, Slovakia and Slovenia) benefited from the contribution made by thestock-flow adjustment.

At present, primary deficits are making a signifi-cant contribution to debt ratio growth. The effectof the difference between nominal interest ratesand nominal growth (snowball effect) – was sig-nificant in Greece and Ireland, as well as in Hun-gary and Latvia, as rising risk premia pushed up debt financing costs.

SUSTAINABLE DEBT LEVELS

The current growth in public debt is high in his-torical terms. It is difficult to determine an opti-mal level of debt (economic theory is not helpful in this regard). In the absence of any consensus on the ideal debt ratio, we assume that a return to the pre-crisis debt level is the minimum nec-essary correction (even though it is evident that the Greek debt ratio was already very high in the pre-crisis period. On the other hand, for exam-ple, Estonia is even now not under any necessity to reduce its debt ratio.

In Table 13, the extent of the necessary correction is illustrated using a scenario in which the debt ratio is reduced to the pre-crisis level in a horizon of 5 or 10 years. We assume that the real implicit interest rates for the countries will be at the 2012 level and that real economic growth will match the EC forecast70 for 2012. The EC assumes

69 According to equation (b6) in Box 3.70 EC (2010).

71NBS


A N N E X 2

Table 13 Primary balance needed to reduce the debt ratio (% of GDP)

Reduction to pre-crisis levelScenario 1

Reduction to pre-crisis levelScenario 2

5 years 10 years (r-g)1) in % 5 years 10 years (r-g) in %Czech Rep. 2.5 1.2 -0.2 3.0 1.7 1Estonia 0.4 0.2 -1.1 0.5 0.3 1Ireland 15.9 8.5 1.4 15.6 8.2 1Greece 15.8 10.2 3.3 12.5 6.9 1Latvia 5.6 2.6 -1.1 6.3 3.3 1Lithuania 4.9 2.2 -2.2 5.9 3.1 1Hungary 0.1 0.1 0.1 0.8 0.7 1Poland 0.8 0.0 -1.7 2.1 1.3 1Portugal 13.3 9.0 5.2 9.3 5.1 1Slovenia 4.9 2.6 0.6 5.1 2.7 1Slovakia 2.7 0.9 -2.9 4.2 2.3 1Source: EC, NBS calculations. 1) EC forecast for 2012.

Chart 82 Debt-to-revenue ratio (%)

Source: EC, NBS calculations. 1) EC projection.

400

350

300

250

200

150

100

50

0

IEGRPT

SISKEE

20022000 2004 2006 2008 20121)20101)

400

350

300

250

200

150

100

50

0

CZLVLT

HUPL

20022000 2004 2006 2008 20121)20101)

a positive growth differential for Ireland, Greece,Lithuania and Portugal – i.e., a more demanding position for fiscal consolidation. Other countriescould take advantage of a negative differential.

The scenario 1 results indicate how demanding the consolidation should be. For countries with a high differential (r-g), it would be very demanding toconsolidate in the given scope within the stipu-lated time horizon, since the selected assumptions require a very high level of primary surpluses.71

Scenario 2 illustrates how the required scope of consolidation is affected by the value of the differential between growth and interest rates. If we assume that countries record the same differential (r-g) during consolidation, at the level of 1% (where implicit interest rates are 1% higher than real growth), the most indebt-ed economies could reduce their primary bal-ance and countries with a negative differential would have to consolidate at a more intensive pace.

71 Annual consolidation with a primary balance of up 3% can be considered feasible. In the past, Belgium and Bulgaria had a primary balance of 6% of GDP for a period in which they reduced excessive public debt. The IMF programme for Greece assumes that the country’s consolidation will be supported with privatisation revenues.

72NBS


A N N E X 2

Where a country loses the advantage of the neg-ative differential (r-g), consolidation becomesmore demanding. In order to stabilise the debt ratio, it is necessary to achieve a higher primary balance surplus. For that to happen, the govern-ment needs to have large and stable revenues. The ability of the general government sector to generate revenue is illustrated by the debt-to-government revenue indicator. Its high value indicates a disparity between the acquisition of funds for public sector financing and the level of(accumulated) liabilities that have to be repaid; it often indicates potential problems in debt sus-tainability.

For emerging economies that have gone into de-fault since 1998, the average value of this indica-tor is 350%, while for advanced, non-defaulting economies its average level is 250%.72

Charts 82 indicate that the main problem in this regard is again the positions of Greece and Ire-land, which have unfavourable and rising debt-to-revenue ratios. By contrast, the new Member States are in a substantially better condition, even though their ratios have evidently been deteriorating since the outbreak of the crisis and also need to be corrected.

IMPACT OF THE FINANCIAL AND ECONOMIC CRISIS

The crisis period generally entailed the deterio-ration of fiscal positions, rises in the real costs ofdebt financing due to increasing interest rates,and a decline in inflation. The sustainability ofpublic finances was diminished by the combina-tion of these adverse factors. In such altered cir-cumstances, it became necessary to change the strategy of debt management/debt reduction.

A key factor in future developments will be the extent to which the rate of growth of potential output recovers. Slower growth may be linked to a lower rate of inflation, which would in turn passthrough to an increase in real interest expenses. With financial markets perceiving an escalationin risks, it may be assumed that debt financingcosts will rise. In some countries under review, the general government deficit is largely a struc-tural problem, meaning that the contribution of any further recovery to a reduction in the deficitmay be only limited. Tax revenue losses could be permanent or long-term, since tax revenues from

financial assets and property during the boomovervalued the revenue side of the budget.

Any slowdown in potential output growth would make the stabilisation of debt ratios more demanding. It will be important to ensure that debt is reduced through primary balance con-tributions and interest payments.73 The question is: to what extent would governments be willing and able to modify fiscal policy in this way – es-pecially in those countries that do not have past experience of such a tight fiscal policy?

RISKS OF HIGH DEBT

High public debt has an adverse effect on theeconomy. The results of empirical studies reveal that countries in which the debt ratio exceeds 90%, have lower GDP growth and that this effectis more pronounced when the share of external debt is high (Reinhart and Rogoff, 2010). Whendebts need to be repaid, it means that large amounts of funds must be allocated for this pur-pose – funds that therefore cannot be used to develop the economy’s potential.

To stabilise the debt at a high level means having to restrict the flexibility of fiscal policy and reducingits ability to respond to shocks. At the same time, the flexibility of fiscal policy as an instrument foreliminating the effect of asymmetric shocks is nowbeing emphasised, especially in the case of coun-tries that are members of the monetary union.

A potential problem in a country having a long-term, persistently high level of debt is that interest rates spiral upwards and push up the debt, thereby adversely affecting market expectations regardingthe country’s ability to repay its sovereign debts. Furthermore, the rise in the risk premium is in-creasing financing costs and causing a shorteningof refinanced debt maturities, thereby impairingthe portfolio parameters and increasing risks in the future. High indebtedness is a particularly pressing issue for small economies, which are more vulner-able to shifts in financial market sentiment.

Another problem related to the bad state of pub-lic finances is that the conduct of monetary policybecomes more complicated, as a conflict emerg-es between fiscal and monetary policy. When thedebt ratio is high there is a greater risk that fiscalpolicy will push up inflation expectations, since

72 World Economic Outlook, 2003.73 For an analysis of the response of

the primary balance to the debt ratio, see Hajnovič (2011).

73NBS


A N N E X 2

the uncertain outlook for public finances makesit difficult to estimate future developments andto set interest rates at an appropriate level (Cec-cetti, 2010). A central bank that follows a policy of inflation targeting must respond to the situ-ation by tightening monetary policy. In doing so, it will counteract the need to reduce debt servicing costs – given the rise in interest rates in a low-inflation environment.

In response to the financial crisis, the ECB (andother central banks in advanced market econo-mies) have cut interest rates substantially and adopted non-conventional measures, includ-ing some of a quasi-fiscal nature.74 At the same time, the central banks are exposing themselves to the risk of potential losses (Cottarelli, 2009). Any return to “normality” would be expected to include a re-tightening of monetary conditions and a shrinking of central bank balance sheets.

CONCLUSION

In all of the EU countries compared in this paper, benign macroeconomic conditions in the pre-cri-sis period contributed to a reduction in the pub-lic debt. The favourable debt dynamics have not been vigorously exploited for the consolidation of public finances. On the contrary, an environmentof low real interest rates has given the private sec-tor, too, an incentive to borrow. As a result, private sector balances are also subject to mounting risks, particular in those countries where lending in for-eign currencies is well established. The crisis period brought about a modification ofinflation, interest rate, and output levels. In thesechanged circumstances there was a heightened need to adjust debt ratio reduction strategies. What will be crucial to future developments is whether the rate of growth of potential output will return to its pre-crisis level. Slower growth would entail a decline in inflation, which wouldresult in higher real interest rates. If potential out-put growth slowed over the long run, debt reduc-tion would have to be achieved through primary balance contributions and interest payments.

Slovakia has one of the lowest debt ratios of any country in the euro area. However, as a small economy with a lower economic level, it must heed the fact that markets can reassess fiscalrisks, and the effect on interest rate spreadsmay appear even at debt levels that are lower than the Maastricht threshold. At the same time, these effects are non-linear and highlydestabilising.

References

Allen, M., Rosenberg, C., Keller, C., Setser, B., Roubini, N. “A Balance Sheet Approach to Financial Crisis”, IMF Working Paper 02/210, 2002.

Chalk, N., Hemming, R., “Assessing Fiscal Sustainability in Theory and Practice”, IMF Working Paper 00/81, 2010.

Ceccetti, S.G., Mohanty, M.S., Zampolli, F. (2010), “The future of public debt: prospects and implications”, BIS, 2010.

Cottarelli, C., Vinals, J., “A strategy for renormalizing fiscal and mon-etary policies in advanced economies”, IMF Staff Position Note,2009.

Das, S.U., Papapioannou, M., Pedras, G., Ahmed, F., Surti, J., “Managing Public Debt and Its Financial Stability Implications”, IMF, 2010.

Eminescu, S.J., “Structure of Government Debt in Europe in 2009”, Eurostat, Statistics in focus 3/2011.

Escolano, J., “A Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates”, IMF, 2010.

European Commission, European Economic Forecast, May 2011,

Gardo, S., Martin, R., “The Impact of the Global Economic and Financial Crisis on Central, Eastern and South-Eastern Europe”, Occasional Paper Series, No 114, ECB 2010.

Hajnovič, F., Zeman, J., Žilinský, J. “Konsolidačné úsilie a kritická hranica vládneho zadlženia v krajinách EÚ, NBS, 2011.

Lewis, J., “How has the financial crisis affected the Eurozone accessionoutlook in central and eastern Europe?”, De Nederlandsche Bank 2010.

Luengnaruemitchai, P., Schadler, S., “Do Economists’ and Financial Markets’ Perspectives on New Members of the EU differ?”, IMFWorking Paper 07/65, 2007.

Reinhart, C., Rogoff, K., “Growth in a time of debt”, CEPR DiscussionPaper 7661, 2010.

“Public debt in emerging markets: Is it too high?”, World Economic Outlook, IMF, September 2003.

74 Quantitative easing – a policy of purchasing government securities.

74NBS


A N N E X 3

Chart 83 Interest rates on new housing loans to households with an initial rate fixation period of up to 1 year (%)

Source: ECB.

Chart 84 Interest rates on new housing loans to households with an initial rate fixationperiod of between 1 and 5 years (%)

Source: ECB.

8

7

6

5

4

3

2

1

0

ATETITSI

BEFILUSK

2006 2009

CYFRMTDE

GRNLESIR

PT

2008 20112007 2010

9

8

7

6

5

4

3

2

1

0

ATFILU

BEFRNL

2006 2009

CYGRSK

DEIRES

IT

2008 20112007 2010

3 INTEREST RATES ON LONG-TERM HOUSING LOANS TO HOUSEHOLDS IN THE SLOVAK REPUBLIC

FRANTIŠEK HAJNOVIČ, JÁN KLACSO

Beginning from 13 May 2009, the ECB gradually cut its base rate to 1.0% in response to the effectsof the economic and financial crisis. This reduc-tion was accompanied by a drop in EURIBOR interbank interest rates, as well as by a steady drop in retail lending rates in a majority of euro area countries. With the Slovak Republic having joined the euro area on 1 January 2009, the fact that housing loan interest rates in this coun-try have developed differently from those inmost other euro area countries has given rise to discussion.75 The attention paid to these interest rates reflects the fact that movements in interestrates on housing loans to households send the public an important signal about the situation in the credit market. Before the differing devel-opments can be explained or assessed, it is nec-essary to identify the factors that influence thelevel of these interest rates.

In this paper, we examine interest rates on new housing loans to households – i.e. loans for new

projects or loans used to refinance earlier loansat the actual lower rates of interest. Specifically,we will analyse the development of interest rates on new housing loans that have an initial rate fixation period of up to 1 year and on those thathave a fixation period of between 1 and 5 years.Such loans constitute the bulk of the housing loans provided to households in Slovakia; loans with an initial rate fixation period of more than5 years are seldom provided or requested.

This analysis follows up a study previously pub-lished by one of the authors76 and information from the Analysis of the Slovak Financial Sector for 2010 (“the ASFS”).77 Based on the plotted de-velopment of interest rates on loans that have an initial rate fixation period of up to 1 year, Klacsonoted that the rates in Slovakia in the period after the country joined the euro area differedconsiderably from the rates in other euro area countries. Using a model, he went on identify a relationship between interest rates on loans

75 This is one example of the conse-quences of the common currency − of how it allows prices to be compared.

76 Klacso, Ján, (2010), “Analysis of in-terest rates on retail housing loans with fixation of up to one year”,BIATEC, Národná banka Slovenska, Bratislava, August.

77 NBS, “Analysis of the Slovak Finan-cial Sector for 2010”, Bratislava (available at: http://www.nbs.sk/_img/Documents/_Dohlad/ORM/Analyzy/2010-2a.pdf).




75NBS


A N N E X 3

with a fixation period of up to 1 year and yieldson Slovak government bonds with 2 years ma-turity. He also demonstrated that these retail in-terest rates are affected by the level of liquidityin the government bond market. In the ASFS, it is stated that interest rates fell far more sharply in the fourth quarter of 2010 than had been expected on the basis of this model. Based on market information, this decline was attribut-ed to stronger competition in the provision of long-term loans to households − banks that in the past had a smaller share in this market have strengthened their position by offering loans atlower rates of interest.

In this analysis, we have specified and supple-mented the arguments made in the mentioned works. The results of a panel regression form the basis of our observation that banks in Slovakia behaved differently in the period leading to upthe outbreak of the financial crisis and followingthe crisis that is approximately coterminous with the period in which the decision was taken on Slovakia’s entry into euro area. We then describe this different behaviour using simple models forhousing loan interest rates for the period before and after euro area entry. We pay particular at-tention to determining the effect of competitionin the banking sector on the level of housing loan interest rates. Finally, we identify the effectthat property price increases have had on these rates.

3.1 THE KEY FACTORS THAT MAY HAVE AFFECTED THE DEVELOPMENT OF INTEREST RATES ON LONG-TERM HOUSING LOANS TO HOUSEHOLDS IN SLOVAKIA

The retail lending rates charged by Slovak banks are in most cases not linked directly to a market rate (e.g. EURIBOR), and therefore the pass-through of market factors and the Slovak banking sector’s particularities to the develop-ment of these rates can be estimated only indi-rectly. The principal explanatory factors in this regard are:• interbank interest rates (EURIBOR, and previ-

ously BRIBOR): these interest rates indicate the price at which banks can obtain funds on the interbank market, i.e. the price of the funds used to cover or provide loans;

• government bond yields: for banks, govern-ment bonds represent an alternative form of investment that offer relatively low risk incomparison with either retail or corporate loans. The yields on these bonds therefore provide banks with opportunity cost informa-tion;

• steepness of the yield curve: even though housing loans usually have a shorter initial rate fixation period (up to 1 year or up to 3years), their maturity is longer and far exceeds the maturity of the funds borrowed to cover these loans. The steepness of the yield curve indicates, inter alia, the expected change in interest rates. An expected rise in interest rates implies a higher future cost of interbank borrowing. These higher future costs may be priced into current bank lending rates in order to cushion banks to some extent from their future higher borrowing costs;

• customer credit risk: it is relatively difficult toselect a direct indicator of customer credit risk, since basically each loan is assessed on its merits and each customer represents a different counterparty risk. Despite this di-versity, however, it may be assumed that the average credit risk premium for the sector indicates with a sufficient degree of preci-sion the sector’s exposure to this risk. It is, of course, questionable, whether this premium, which may be constant over a shorter time interval, has not changed in response to certain significant events (such as the eurochangeover);

• the level of competition: as competition in-creases, interest rates would be expected to fall, down to a certain limit. From market information, it is clear that the pass-through of competition to the lending policies of certain banks was relatively substantial dur-ing the last quarter of 2010 (see the ASFS). From among the many indicators that may be used to measure the level of competition, this analysis opts for the concentration of the total long-term lending to households in March 2011, i.e. the overall market share in these loans of the banks that have the larg-est shares (the First 3, First 5, First 7, and First 10).

• exchange rates: Slovak banks borrow and lend almost entirely in the domestic currency, but in the past, exchange rate movements con-veyed information about the course of inter-

76NBS


A N N E X 3

Chart 85 Market concentration in housing loans to households (%)

Source: NBS.

Chart 86 Dynamics in market concentration in housing loans to households (%)

Source: NBS. Note: Δ – year-on-year change.

100

90

80

70

60

50

40

30

First 3 First 7

First 5 First 10

2004 2005 2006 2007 2008 2009 2010 2011

0.3

0.2

0.1

0

-0.1

-0.2

∆ (First 10-First 3)∆ (First 10-First 7) ∆ (First 5-First 3)

∆ (First 10-First 5)∆ (First 7-First 5)

2010 2011

est rates which banks could take into account when setting retail interest rates;

• property price movements: rapidly rising prop-erty prices lower the real level of interest rates and create scope for increasing them. Further-more, a robust increase in property prices is, as a matter of course, reflected in expectations forfurther price growth, which in turn drives up demand from households. Elevated demand also increases the potential for interest rate rises. By the same token, a decline in property prices puts downward pressure on interest rates;

• institutional factors: the enforceability of laws, the costs and delays involved in the realisation of collateral, the legislative treatment of rela-tions between creditors and borrowers, and the protection of their rights are all important factors, too.

3.1.1 MARKET CONCENTRATION IN LONG-TERM LENDING TO HOUSEHOLDS

The competition environment can be assessed in various ways. We proceeded on the assump-tion that the level of competition in the segment of banking business under review has an inverse relationship to the level of concentration in the segment. We express the market concentration in long-term lending to households in terms of the cumulative shares in this market of the banks that have the largest shares. Chart 85 shows how this concentration has developed since January 2004.78

As Chart 85 shows, the market share of the three leading banks in the sector of long-term lending to households rose gradually for a period after 2004, as did the market share of the five lead-ing banks. These market shares then recorded slower growth and, in mid-2010, a slight de-cline, which indicated rising competition from the group of banks that have lower shares in the total volume of long-term loans to households. The rise in their cumulative market share is il-lustrated by, for example, the difference (First10– First 5).

The rising competition from smaller providers of long-term loans to households is further illus-trated in Chart 86, which makes clear, in particu-lar, the rapid rise in the cumulative market share of those banks that rank between fifth and tenthplace in terms of their share in long-term lending to households.

3.2 INTEREST RATES ON HOUSING LOANS TO HOUSEHOLDS WITH AN INITIAL RATE FIXATION PERIOD OF UP TO 1 YEAR (IN THE EURO AREA)

The development of retail interest rates on hous-ing loans in different euro area countries can becompared by looking at interest rates on loans

78 The ranking of the most significantbanks is determined according to their market share in long-term lending as at March 2011. The sum of total market share for the 3, 5, 7, and 10 most significant banks inthe market determined the respec-tive indicators of concentration: First 3, First 5, First 7 and First 10.

77NBS


A N N E X 3

that have an initial rate fixation period of up to1 year, since this information is available for all euro area countries. Chart 83 shows that in Slova-kia (and Cyprus) the average rate on such loans has fallen only slightly since mid-2008, whereas in the other euro area countries it has declined substantially. The gap between the rate in Slova-kia and the rates in the other countries ranged between 1 and 3 percentage points.

To better interpret and understand the back-ground to these differences, we estimated a sim-ple panel regression model for the above-men-tioned rates in different euro area countries. Theexplanatory variable was the 12-month EURIBOR. In the case of Slovakia we used the BRIBOR for the period until the end of 2008.

In other member countries, a relatively large pro-portion of loans are granted with interest rate that is linked directly to interbank rates, i.e. the retail rate is set in the credit agreements as the EURIBOR + premium. The estimation also reflects this fact,and its results are shown in Table 14. It was ap-parent that the largest influence on interest ratescame from a direct change in interbank rates, i.e. from their short-term dynamics. This means that a change in interbank rates feeds directly through to retail rates. The correction of the deviation from the long-run relationship is relatively weak. The estimations confirmed that the behaviour of in-terest rates in Slovakia and Cyprus differed mark-edly from the behaviour of rates in other euro area countries. They showed, inter alia, that interest rates in Slovakia following the country’s entry into the euro area were subject to an additional pre-mium that made them higher than rates in other euro area countries and also higher than the rates in the previous period.

3.2.1 PANEL ESTIMATION OF INTEREST RATES FOR THE EURO AREA

The response of the euro area interest rates un-der review and its change in the period after Slo-vakia joined the euro area is fully documented in Table 14. The starting point for the analysis and assessment of the differences between Slovakiaand other euro area countries was a panel esti-mation in which we assumed that the relation-ship between lending rates and money market rates was the same for all euro area countries – expressed by the common parameters in this relationship. In formal terms, this relationship

implies a so-called error-correction model and an assumption that, in the long run,79 the interest rate on long-term housing loans to households with an initiation rate fixation period of up to 1year (“IR”) is determined by a linear relation with the money market rate. The most optimal rate for explanatory purposes was the 12-month EURI-BOR. Using so-called fixed effects, we expressedthe differences between countries as differentinterest-rate levels:

d (R i,t

) = c(2) * (Ri,t–1

– c(1) – c(3) * EURIBOR12Mt–1

) + FE

i,

where (IRi,t

) denotes the retail interest rates on housing loans with an initial rate fixation periodof up to 1 year for country i at time t, and FE

i is

the fixed effect for country i. We then modifiedthis long-run relationship by expressing short-run effects.

Parameter c(3), which should be positive, shows the strength of the proportion in this relationship. If c(3) = 1, there is a complete pass-through (one to one) to retail interest rates of a rate change in the given country or of a difference in interbank ratesbetween countries – whether such changes or dif-ferences are upward or downward. If parameter c(3) is less than 1, the pass-through of any move-ment in interbank rates to retail rates is only par-tial, but this may imply that differences betweenretail rates in different countries are only partiallyrelated to money market rates (we identifiedprecisely such a relationship, as we show later). If parameter c(3) has a lower value in the second period, it implies that retail rates in the in second period are less closely related to interbank rates. Since these rates were falling, it implies that banks only partially passed on this decline to retail rates.

In this model, we assume that movements in lending rates are linked to movements in money market rates. A further two key parameters are entered in the model. Parameter c(1) denotes the common fixed premium for retail rates80 vis-à-vis the level based on the relation with interbank rates for a group of countries – in our case, for the euro area countries. Parameter FE

i denotes

the additional premium for retail rates in the given country i. These three parameters provide a profile of the interest rate policy of banks, bothin the euro area as a whole and in a particular country within it. We will call parameter c(1) the

79 In this instance, the term “long run” is used only to distinguish trend relationships between variables (so-called integrated variables) and their changes, which act as a short-run impulse effect on interest rates.

80 This risk premium includes the risk premium for individual risks not covered by the model and the aver-age profit margin of banks.

78NBS


A N N E X 3

Table 14 Panel estimation results for the euro area

EC form parameters Jan. 2006 – June 2008 July 2008 – Mar. 2011

Error-correction parameter -0.202 -0.115Common premium for the euro area (percentage points) 1.637 1.92112-month EURIBOR (t-3) 0.813 0.813Additional premium for individual euro area countries (percentage points)

AT 0.161 -0.332BE -0.096 -0.175CY 0.260 2.106DE 0.610 0.111ES -0.021 -0.496ET 0.317 0.113FI -0.453 -1.197FR -0.471 0.229GR -0.384 0.376IR -0.256 -0.439IT 0.091 -0.783LU -0.382 -1.339MT -0.700 -0.001NL -0.029 0.429PT -0.198 -0.657SK 0.338 1.837SL 1.128 0.217R2 32.88 % 58.34 %

Adjusted R2 29.47 % 56.76 %Durbin-Watson statistic 1.96 1.74Source: NBS, own calculations.

common premium for interest rates (“common premium”), and parameter FE

i the additional

premium for interest rates for country i (“the ad-ditional premium”).

The higher the value of parameter c(1), the great-er the extent to which banks have “fixed” retailinterest rates. In conjunction with a lower value of parameter c(3) (or c(3) + FE

i ), such an interest

rate policy implies that banks in the euro area, or in a given country, have hedged against a fall in interest rates by ensuring that they fix them toa greater extent than they link them to interbank rate movements.

We made the panel estimation on the basis of monthly data for the period from January 2006 to March 2011 (where the respective data were available) using OLS. Since the data for certain countries were not available at the beginning of the period under review, the estimation was made using data for periods of varying lengths for a panel of countries.81

According to the estimation, the relationship between interest rates on housing loans and the 12-month EURIBOR did not change in the period after the crisis and Slovakia’s entry into the euro area (parameter 0.813); however, the response to the deviation from this relationship is weaker (the value of the error-correction parameter fell from 0.202 to 0.115). The common premium for interest rates increased marginally (from 1.637 percentage points to 1.921 percentage points). The most substantial change, however, is in the additional premium for certain countries, includ-ing Slovakia. As a result, the overall premium in Slovakia represented 1.8 percentage points.82

3.3 ANALYSIS OF INTEREST RATES IN SLOVAKIA WITH AN INITIAL RATE FIXATION PERIOD OF UP TO ONE YEAR

The first question is: to what extent are lendingrates affected by the cost of interbank borrow-ing and to what extent by yields on an alternative

81 The so-called unbalanced panel.82 The only country for which a larger

total premium was reported was Cyprus, and this is also reflected inthe plotting of retail rates.

79NBS


A N N E X 3

Chart 87 Retail and interbank rates and Slovak government bond yields (%)

Source: NBS, ECB.

Chart 88 Difference between long andshort-term interest rates (p.p.)

Source: NBS, ECB.

8

7

6

5

4

3

2

1

0

Housing loans with an initial rate fixation period of up to 1 year 12-month EURIBOR12-month BRIBOR

1-year government bonds2-year government bonds3-year government bonds

2008 2010 20112006 2007 2009

3

2

1

0

-1

5Y – 1Y10Y – 1Y

5YSK – 1YSK10YSK – 1YSK

2008 2010 20112006 2007 2009

form of investment (Slovak government bonds)? The difference between these two factors wasrelatively insignificant until the end of 2008, withtheir development showing considerable coline-arity. From January 2009, after Slovakia joined the euro area, the BRIBOR interbank rates ceased to be listed and were replaced by EURIBOR rates. It is ap-parent, however, that the development of implied Slovak interbank rates has so far largely mirrored that of EURIBOR interbank rates (the Analysis of the Slovak Financial Sector for the Year 2010).

From estimations, it may be concluded that in-terbank interest rates (in this case, the 12M BRI-BOR/EURIBOR) have a certain explanatory power for the development of interest rates on housing loans with an initial rate fixation period of up to1 year. It is apparent, however, that the estimated relationship for the level of rates has changed over time; the turning point may have occurred at the time when Slovakia was receiving the green light for entry into the euro area, i.e. in June 2008. Based on the estimation of the given equation for the period from January 2006 to June 2008 and from July 2008 to March 2011, it appears that the pass-through of interbank rate movements to re-tail rates was far lower in the second period than in the first period. It also appears that where therehad been a deviation from the simulated relation-ship, the speed of the return to it was greater in the first period mentioned. Thus it was confirmed

that the interest policy of banks before and after July 2008 was different.

We also found that yields on Slovak government bonds, like interbank rates, have a capacity to ex-plain the retail rates under review and that this ca-pacity is even greater than in the case of interbank rates. The stronger explanatory power of govern-ment bonds can be seen in the better statistical explanation of retail rate developments in the second period – during the interval (06/2008–03/2011). In the model in which we used 3-year government bonds to explain the development of retail rates, it was also the case that the pass-through of yield changes to retail rates was weak-er in the second period and that the premium for interest rates in the model increased in the second period; this happened despite gradually rising competition from less significant lenders. The useof the three-year government bond yield meant that liquidity movements were reflected in themodel to a certain extent. These may have played a relatively significant role in the second period(from July 2008). Taking into account movements in the SKK/EUR exchange rate did not significantlyimprove the estimation.

3.3.1 MODEL OF INTEREST RATES IN SLOVAKIA WITH AN INITIAL RATE FIXATION PERIOD OF UP TO 1 YEAR.

We expressed the development of interest rates using an error-correction model, in which there is

80NBS


A N N E X 3

Table 15 Estimation of the error-correction equation, including the impact of 12-month EURIBOR (BRIBOR) and lending market concentration

Error-correction model Jan. 2006 – June 2008 July 2008 – Mar. 2011

Error-correction parameter -0.29 *** -0.20 **Premium (fixed margin), percentage points 1.24 * 4.59 ***12-month EURIBOR(BRIBOR), t-2 1.06 *** 0.39 ***12-month EURIBOR(BRIBOR), change t-1 0.28 ** 0.14 *Concentration, change (First 10 – First 5) -0.79 **Concentration, change (First 10 – First 3) -0.18 ** R2 67.14 % 50.65 %Adjusted R2 61.88 % 41.52 %Durbin-Watson statistic 2.25 1.88 Source: NBS.Note: Asterixs denote significance levels of coefficient stimates.* Significance level of 10%.** Significance level of 5%.*** Significance level of 1%.

Table 16 Estimation of the error-correction equation, including the impact of the yield on the 3-year government bond and lending market concentration


Error-correction parameter -0.21 ** -0.41 ***Premium (fixed margin), percentage points 1.22 3.33 ***Yield on the 3-year government bond, t-2 1.12 *** 0.60 ***Yield on the 3-year government bond, change t-1 0.38 *** 0.16 **Concentration, change (First 10 – First 5) -0.29 *** Concentration, change (First 7 – First 5) -0.41***R2 61.81 % 56.84 % Adjusted R2 55.70 % 50.67 %Durbin-Watson statistic 1.86 1.91Source: NBS.Note: Asterixs denote significance levels of coefficient stimates.* Significance level of 10%.** Significance level of 5%.*** Significance level of 1%.

assumed to be a “long-run” relationship between the retail rate and interbank rate (12-month EURIBOR/BRIBOR) or yields on Slovak govern-ment bonds with (3-year maturity).

In both models, we identified the statisticallysignificant effect of competition from smallerproviders of long-term loans to households. For example, the stronger competition they brought to the market in long-term loans with an initial rate fixation period of between 1 and 5 years –together with their rising share of the long-term loan market (particularly at the end of 2010) – put downward pressure also on interest rates on loans with an initial rate fixation period upto 1 year. In the case of these interest rates, the

competition caused them to decline gradually in 2010, by around 0.4 to 0.7 percentage points.

3.4 ANALYSIS OF INTEREST RATES IN SLOVAKIA WITH AN INITIAL RATE FIXATION PERIOD OF BETWEEN 1 AND 5 YEARS

As for retail interest rates in Slovakia on new hous-ing loans that have an initial rate fixation periodof between 1 and 5 years, as in the previous case, we indetified an effect of 3-year Slovak govern-ment bonds yields based on our estimations. This implies that banks, when setting these interest rates, also took account of the yield on an alter-

81NBS


A N N E X 3

Table 17 Estimation of the error-correction equation, including the impact of the yield on 3-year government bonds and lending market concentration


Error-correction parameter -0.99 *** -0.41 ***Premium (fixed margin), percentage points 4.25 *** 4.40 ***Yield on 3-year government bonds, t-2 0.42 *** 0.44 ***Concentration, change (First 10 – First 5) -0.60 *** -1.37 **R2 63.70 % 34.12 %Adjusted R2 57.90 % 24.70 %Durbin-Watson statistic 2.00 1.99Source: NBS.Note: Asterixs denote significance levels of coefficient stimates.* Significance level of 10%.** Significance level of 5%.*** Significance level of 1%.

native investment. These rates, too, were affectedby changes in the level of market competition in long-term lending to households.

In contrast to the estimated model parameters for loans with an initial rate fixation period ofup to 1 year, the parameters in this case did not change substantially when the overall period was divided into two parts (from January 2006 to June 2008 and from July 2008 to March 2011). The main changes occurred in the speed of re-turn, which fell sharply during the second pe-riod under review. However, the model’s lower explanatory capacity in the second period indi-cates that factors which are not included, or only partially included, in the model had an increas-ing influence in the period after Slovakia joinedthe euro area, and/or as a result of the effect ofthe global crisis on the Slovak economy.

The changing competition environment had a marked influence. The parameter of the effectof competition from smaller lenders is several times higher for this type of loan than it was for loans with an initial rate fixation period of up to1 year. Furthermore, the intensity (parameter) of the effect of competition on interest ratesrose twofold after Slovakia joined the euro area – from 0.6 to 1.37. According to the estimation results, the competitive pressure during 2010 caused interest rates on this type of loan to fall by around 1.5 percentage points. As in the previ-ous case, the inclusion of movements in the SKK/EUR exchange had a certain explanatory power until the end of the first half of 2008, but did notsignificantly improve the estimation.

3.4.1 MODEL OF INTEREST RATES IN SLOVAKIA WITH AN INITIAL RATE FIXATION PERIOD OF BETWEEN 1 AND 5 YEARS

The estimation of interest rate developments was made using an error-correction model, which as-sumed the existence of a relationship between the retail rate and the yield on Slovak govern-ment bonds. For the estimation results stated in this part, the yield on 3-year government bonds was used.

3.5 EFFECT OF PROPERTY PRICES ON HOUSING LOAN INTEREST RATES

In the period before Slovakia joined the euro area and before the Slovak economy was hit by the global financial crisis, property prices in the coun-try were booming. The main drivers of this growth was rising demand, supported by the favourable development of interest rates, and the availability (supply) of housing loans. There is also a feedback loop between property prices and interest rates – a high rate of growth in property prices slows the increase in real interest rates on housing loans (or even causes them to decline) and accelerates demand for housing loans, which in turn creates scope for raising interest rates.

To analyse the effect of property prices on hous-ing loan interest rates, we included the annual rate of growth in property prices in the model for interest rates on new housing loans to house-holds – both on loans with an initial rate fixationperiod of up to one year and on loans with one of between 1 and 5 years.83

83 Residential property prices in Slovakia have been systemati-cally tracked since 2002, first on anannual basis and then quarterly, using sale prices that are jointly processed by the National As-sociation of Real Estate Agencies and Národná banka Slovenska. To analyse their effect at monthlyintervals, we interpolated them using the Cardinal Spline approach in E-views.

82NBS


A N N E X 3

Table 18 Results of the estimation of models for interest rates on housing loans in which the effect of residential property prices is expressed

Dependent variable: month-on-month change in the interest rate

factor/parameterfixation period of up to

1 yearfixation period of between 1

and 5 years

Error-correction parameter -0,404 -0,397

Base level, percentage points 4,886 7,427

Yield on 3-year bonds 0,441 0,212

Competition from smaller lenders -0,091 -0,218

Annual rate of growth in house and apartment prices 0,0013 0,0016

R2 0,480 0,233

Adjusted R2 0,430 0,154

Durbin-Watson statistic 1,530 1,789

Period: Dec. 2004 – Mar. 2011Source: NBS.

Chart 89 Three-year government bond yields and annual inflation in prices ofapartments and houses in Slovakia (%)

Source: NBS.

6

5

4

3

2

1

0

Yield on 3-year Slovak government bondsAnnual rate of change in prices of apartments and houses in Slovakia (right-hand scale)

2005 2006 2007 2008 2009

40

30

20

10

0

-10

-202010 2011

3.5.1 MODELS FOR INTEREST RATES WITH AN INITIAL RATE FIXATION OF UP TO 1 YEAR AND 1 TO 5 YEARS IN WHICH THE EFFECT OF PROPERTY PRICES IS EXPRESSED

Table 18 shows the estimation results for the parameters of the interest rate model for both types of loans. We show only the parameters of the long-run part of the model, without lags.84

The estimations of premium parameters in the models differ – the premium is higher for inter-est rates with an initial rate fixation period of between 1 and 5 years. In the case of these in-terest rates, the relationship to yields on 3-year government bonds is weaker, but the effect of competition from smaller lenders was strong-er. As these banks increased their market share in long-term lending to households by 1 per-centage point, interest rates with a fixation pe-riod of up to 1 year fell by 0.1 percentage point and those with a fixation period of between 1 and 5 years declined by 0.2 percentage point.85 The pass-through of property prices to interest rates was also significant. Although the value of the respective parameter is low, it should be noted that property prices were rising (and then falling) rapidly – by tens of percent year-on-year.

By plotting the stability of the parameters, two significant turning points became apparent. These were in July 2008 (decision on Slovakia’s entry into the euro area and response to the crisis) and at the beginning of 2010 (strength-ening of market competition). The parameter

changes corresponded to our findings based on estimations for the period before and after euro area entry. The effect of property prices in interest rates is smaller now than it was in the past. The effect of competition became more pronounced in the market in loans with a fixation period of between 1 and 5 years. It should, however, be noted that, despite show-ing high statistical significance, the estima-tions (and therefore also the conclusions) are not sufficiently robust and require further in-vestigation.

84 There is a lag of 4 months in the effect of government bond yieldsand 5 months in the effect of prop-erty prices. Both models include short-run effects – changes incompetition (change in the market share of smaller lenders at time t), changes in government yields (t-4).

85 During 2010, the market share of smaller lenders (ranked fifth totenth) increased by 2.4 percent-age points, which in the long-run caused interest rates with a fixationperiod of up to 1 year to fall by 0.24 percentage point and those with a fixation period of between 1 and5 years to decline by 0.48 percent-age point. In addition, competition from smaller lenders caused an even larger short-run movement in interest rates.

83NBS


A N N E X 3

CONCLUSION

The results of the simple analysis presented here show that in the period approximately after June 2008, certain divergences existed between the setting of interest rates in Slovakia and in other euro area countries and that bank inter-est rate policies for long-term housing loans to households underwent a change in comparison with the previous period. In most other euro area countries, interest rates on housing loans to households are linked to interbank rates, but in Slovakia this link has been weakened, as (fixed) premiums for interest rates have assumeda greater role in interest rate policy.

In several euro area countries there is a contrac-tual link between retail interest rates on hous-ing loans and money market rates. Such a con-tractual link at the level of individual customers does not mean that the pass-through of money market rates to retail rates is automatically pro-portional at the aggregate level, but it does in-crease the predictability of the transmission of the government’s and central bank’s economic and monetary policy aims.

According to estimations, it seems that while bank retail rates in other euro area countries re-flected mainly the cost of interbank borrowing,those in Slovakia were affected (also) by yieldson alternative investments, namely govern-ment bonds. As regards the setting of interest rates on loans with an initial rate fixation periodof up to 1 year, the role of the fixed premiumfor interest rates increased quite substantially in the respective period and the link to money market rates and government bond yields de-clined. The effect of competition on these in-

terest rates was more indirect, and therefore not large, since the competition from smaller lenders was more pronounced in the market in loans with an initial rate fixation period of be-tween 1 and 5 years.

During the period in question – after the reper-cussions of the global crisis on the Slovak econ-omy had become more substantial – it is possi-ble to observe a divergence in bank behaviour also in the setting of interest rates on loans with an initial rate fixation period of between 1 and5 years. The link between, on one hand, housing loan interest rates and, and on the other hand, money market rates and bond yields had been relatively high and, in the case of this type of loan, substantially unchanged. Nevertheless, the response of retail interest rates to market rates slowed During 2010, the pass-through of com-petition from smaller housing-loans providers to this type of loan was significant. This may beexplained by the fact that customer demand for such loans was greater during the period of low interest rates, as people sought to fix their inter-est burden and loan repayments for a longer pe-riod. Therefore, the market rivals also paid atten-tion to that segment.

It was also evident that the level of interest rates was affected by property prices, too. Their rapidgrowth in the past had brought about a decline in real interest rates, stimulated demand for loans, and therefore created a certain scope for raising retail interest rates on housing loans. Overall, however, this growth caused rates to rise by only a few tenths of a percentage point. At present, after the downturn in residential property prices, it contributed to a slight drop in interest rates.

ABBREVIATIONS

85NBS


ABBREVIATIONS

ARDAL Debt and Liquidity Management Agency b.p. basis pointsBRIBOR Bratislava Interbank OfferedRate(Slovakinterbankinterestratefixingupto31December2008)CBOE Chicago Board Options ExchangeCDS credit default swapDFI direct foreign investmentECB European Central BankEC European CommissionEU European UnionEURIBOR Euro Interbank Offered RateFed Federal Reserve SystemGDP gross domestic productH half yearHICP Harmonized Index of Consumer PricesIMF International Monetary FundLTV Loan-to-Value ratioNAV net asset valueNBS Národná banka Slovenska(p) preliminary data PFMC Pension Asset Management Companyp.p. percentage pointsROE return on equitySPMC Supplementary Pension Asset Management CompanySO SR Statistical Office of the Slovak RepublicTARGET Trans-European Automated Real Time Gross Settlement Express TransferTier 1, 2, 3 components of banks’ equity capital

LIST OF CHARTSAND TABLES

87NBS


LIST OF CHARTS

Chart 1 GDP in Q4 2010 7Chart 2 GDP on a quarterly basis 9Chart 3 Advanced equity markets 9Chart 4 Emerging equity markets 10Chart 5 Implied volatility in equity markets

measured by the VIX index 10Chart 6 Commodity price indices 10Chart 7 Interest rate spreads on corporate

bond yields 11Chart 8 Yields on 10-year government bonds 11Chart 9 Bank CDS spreads 11Chart 10 Spreads between yields on

government bonds issued by selected countries and German government bonds 11

Chart 11 Real estate prices 12Chart 12 Bank deposit rates 12Chart 13 Bank rollover requirement, 2011–2012 14Chart 14 Net capital flows 15Chart 15 Foreign currency housing loans as

a share of total housing loans 16Chart 16 Nominal exchange rate of V4

countries‘ currencies vis-à-vis the euro 16Chart 17 GDP 19Chart 18 Labour productivity and wages 20Chart 19 Current account deficit coverage 20Chart 20 External indebtedness 20Chart 21 General government deficit and debt 21Chart 22 Liabilities of general government 21Chart 23 Investments of non-financial

corporations and households 25Chart 24 Outstanding loans to non-financial

corporations and households 25Chart 25 Output, sales and investment 25Chart 26 Business tendency indicators 26Chart 27 Financing of non-financial

corporations by instrument 26Chart 28 Financing of non-financial corpations

by sector 26Chart 29 Savings rate and investment rate 27Chart 30 Unemployment and job vacancy

rates 27Chart 31 Household debt ratios 28Chart 32 Household financial assets 28Chart 33 Amount of assets or managed assets

by financial market segment 30Chart 34 Housing loans to households 30Chart 35 New mortgage loans and other

housing loans 31

Chart 36 Interest rates on new housing loans 31Chart 37 Credit standards for loans to

households 31Chart 38 Household (resident) deposits in the

banking sector 32Chart 39 Interest rates on new household

deposits 32Chart 40 Comparison of sales in selected

sectors with 2008 32Chart 41 Credit standards for new loans to

enterprises 33Chart 42 Loans to enterprises 33Chart 43 Changes in the amount of securities

in banks‘ portfolios 34Chart 44 Foreign debt securities as a share

of total bonds by country as at 31/12/2010 34

Chart 45 Selected interbank assets and liabilities 34

Chart 46 Distribution of ROE in the banking sector 35

Chart 47 Main components of profitability 35Chart 48 Capital position of the banking sector 36Chart 49 Ratio of non-performing household

loans 36Chart 50 Increases in the number of

unemployed 37Chart 51 Share of new housing loans by LTV

ratio 37Chart 52 Non-performing loan ratio in the

corporate sector and year-on-year change in the amount of non-performing loans to enterprises 38

Chart 53 Long-term liquidity ratio of the banking sector 39

Chart 54 Liquid asset ratio of the banking sector 39

Graf 55 Total profits of insurance companies 40

Graf 56 The guaranteed interest rate in comparison with the actual return 41

Chart 57 Net asset value of mutual funds marketed in Slovakia 42

Chart 58 Average returns on mutual funds by fund category 43

Chart 59 Structure of funds‘ assets by main instruments 43

Chart 60 Current value of pension units by type of fund 44

88NBS


Chart 61 Simulated losses from credit risk and market risks in the banking sector 47

Chart 62 Impact of stress scenarios on PFMC funds 47

Chart 63 Impact of stress scenarios on SPMC funds 48

Chart 64 Impact of stress scenarios on collective investment funds 48

Chart 65 Impact of stress scenarios on insurers‘ assets 48

Chart 66 Volume of payments processed in TARGET2-SK (thousands) 50

Chart 67 Value of payments processed in TARGET2-SK (EUR billions) 50

Chart 68 Structure of payments sent by TARGET2-SK participants in 2010 51

Chart 69 Volume of transactions executed in EURO SIPS 52

Chart 70 Value of transactions executed in EURO SIPS 52

Chart 71 Public debt 54Chart 72 Fiscal balance 55Chart 73 Gross debt 64Chart 74 Net debts and fiscal balances 65Chart 75 Real GDP 65Chart 76 Real implicit interest rates 66Chart 77 Differential (r-g) 67Chart 78 Primary balance 67

Chart 79 Differential (r-g) and primary balance – average for 2002-2008 68

Chart 80 Differential (r-g) and primary balance – 2009 and 2012 68

Chart 81 Stock-flow adjustment 69Chart 82 Debt-to-revenue ratio 71Chart 83 Interest rates on new housing loans to

households with an initial rate fixationperiod of up to 1 year 74

Chart 84 Interest rates on new housing loans to households with an initial rate fixation period of between 1 and 5 years 74

Chart 85 Market concentration in housing loans to households 76

Chart 86 Dynamics in market concentration in housing loans to households 76

Chart 87 Retail and interbank rates and Slovak government bond yields 79

Chart 88 Difference between long and short-term interest rates 79

Chart 89 Three-year government bond yields and annual inflation in prices ofapartments and houses in Slovakia 82

LIST OF CHARTS IN THE BOXES

Graf A Stocks of financial assets and liabilities 22Graf B Net lending/borrowing 22

LIST OF TABLES

Table 1 World output and world trade volume 7

Table 2 Real GDP growth 8Table 3 Investments in debt securities of

selected countries as a share of total assets 40

Table 4 Share of equity, foreign-exchange and interest-rate positions in differentsectors of the financial market 42

Table 5 Annual rate of return on pension funds as at 31 December 2010 44

Table 6 Stress testing parameters 46Table 7 Impact of stress scenarios on

banking sector capital adequacy 46Table 8 Recovery of outlays and net direct

cost of financial sector support 54

Table 9 European bank levies 56Table 10 Debt consolidation 64Table 11 Debt-stabilising primary balance

in 2010 68Table 12 Contributions to the debt ratio

change – cumulative for 2002-2008 and 2009-2010 70

Table 13 Primary balance needed to reduce the debt ratio 71

Table 14 Panel estimation results for the euro area 78

Table 15 Estimation of the error-correction equation, including the impact of 12-month EURIBOR (BRIBOR) and lending market concentration 80

Table 16 Estimation of the error-correction equation, including the impact of the

89NBS


yield on the 3-year government bond and lending market concentration 80

Table 17 Estimation of the error-correction equation, including the impact of the yield on 3-year government

bonds and lending market concentration 81

Table 18 Results of the estimation of models for interest rates on housing loans in which the effect of residentialproperty prices is expressed 82

LIST OF BOXES

Box 1 The debtor position of the Slovak economy‘s sectors in 2010 22

Box 2 Special bank levy planned in Slovakia 59Box 3 Mathematical apparatus for the

calculation of government debt dynamics 62

FINANCIAL

STABILITY REPORT

2010

NÁ

ROD

NÁ B

AN

KA S

LOVE

NSK

A

FIN

AN

CIA

L STA

BILI

TY R

EPO

RT 2

010

2010 - nbs.sk · ble development in 2010 was also seen in almost all other sectors of the...

Documents

Transcript of 2010 - nbs.sk · ble development in 2010 was also seen in almost all other sectors of the...